Have you ever wondered if it is possible to use the money you have in your retirement account to invest in real estate?
Or if you are able to use the retirement savings in your 401k to help with a home purchase when housing prices are skyrocketing and you keep getting outbid?
Maybe you want to invest in real estate for higher returns than you can get from more traditional securities like stocks and bonds.
Well, if you don’t have enough money using just your personal funds, there are ways you can use your 401k to buy a house without penalty.
In this article we will help you understand how you can use retirement funds in your 401k and other qualified retirement accounts for a down payment, the rules and restrictions governing these transactions, and the types of real estate investments that you can choose to buy and hold in all qualified retirement accounts including your 401k.
401k Real Estate Investment Rules
When considering buying real estate with a retirement account, it is best to know the real estate investment rules that govern the account you want to use for the purchase.
The rules that you have to be aware of when it comes to investing in real estate in your retirement accounts are prohibited transactions, repayment periods, borrowing amounts, and withdrawal penalties.
For instance, according to 401k real estate investment rules, you cannot purchase rental or commercial property.
You can however, use the funds in an employee sponsored 401k, a simple IRA, or a traditional individual retirement account or IRA( for short) to purchase your first home.
Additionally, it is possible to invest in a real estate investment trust – REIT in your employer sponsored 401k if your company provides that as an option.
If you are interested in purchasing land, farmland, commercial property, or rental property you will either have to use a Solo 401k or a self directed IRA.
With a self directed IRA and a solo 401k, you can invest in and hold these types of properties.
With careful planning, rental properties can be added to your retirement assets to increase the value of your retirement accounts and support you when you are older.
The key is to research custodians who can handle alternative investments and help you set up these accounts.
Using Your 401K To Purchase A Primary Residence
When you are first considering using your 401k or your traditional IRA to purchase real estate, it is a good idea to talk to your plan provider, plan administrator, or custodian.
According to the IRS rules, you are able to use the retirement funds in your 401k to buy a house.
If it is for your first home that will be your principal residence, you can have access to the money in your 401K.
There are two options when it comes to using your 401k to help you purchase a home.
You can either borrow money in the form of a loan or take the money from the 401k as a withdrawal.
The amount of money you are able to borrow from your 401k depends on the number of years you worked at your company and the guidelines of the IRS.
The amount you can borrow is the greater of $10,000 or half of the balance in your account that has been vested, but the loan cannot exceed $50,000.
If your company allows loans from your 401k, you will not be subject to an early withdrawal penalty.
However, you will incur a penalty if you leave your job before paying back your loan within a specific time frame.
The repayment period for a loan against your 401K is 5 years. There is no repayment period for a withdrawal of funds from your 401k.
You will have to pay income taxes on the amount of the withdrawal.
Before considering a withdrawal, check with your plan administrator to see if you are able to take a withdrawal from your 401k.
Companies have restrictions and may only allow you to take a hardship withdrawal if you can prove you are in financial distress.
401k to Purchase Primary Home Rules
When you take out a loan from your 401k you will have to pay the loan back to yourself, plus interest.
When you are repaying the loan back to your 401k, you may not be able to contribute to your 401k. This depends on the rules of your employer.
Additionally, the repayments do not count as a contribution into your 401k so you will not receive a match from your employer on the repayment amounts or tax benefits from the IRS.
If you leave your job before the loan is repaid, you will have to pay the outstanding amount immediately.
If you want to use a traditional IRA for a home purchase, you will have to take a withdrawal.
Under the rules of the IRS, you are able to withdraw $10,000 tax free for your first home purchase.
It is best to weigh your options and see what works best for you depending on the amount of money you need to fund your home purchase.
Qualified Retirement Plans For Real Estate Investment
The real estate market can provide high returns.
Sometimes these returns can be higher returns than the returns you would get if you just invested in the stock market buying mutual funds, stocks, or other traditional securities.
Real estate can also add diversification to your investing portfolio and help increase the money in your retirement accounts.
If you want to buy real estate as an investment and hold it in a qualified retirement plan, you can use the following accounts:
- Self Directed IRA
- Solo 401k
Holding real estate in a qualified plan requires the observance of rules that govern the holding of real estate in the plan in order to avoid:
- prohibited transactions
- additional taxes
- treatment of capital gains
Retirement Account Investment Property Rules
Individuals and entrepreneurs like real estate investors, can use a solo 401k or a self directed IRA as a way to gain tax breaks by using qualified retirement accounts.
All of the money that is needed to maintain your property including paying for property taxes, maintenance fees, and homeowner association fees have to come from the bank account or brokerage account of the qualified retirement account that holds the real estate.
All rental income has to go back into the qualified retirement account and is added to your retirement savings.
In general you cannot be paid directly or have close relatives be paid or compensated in anyway from assets like real estate purchased in the self directed IRA or solo 401k.
Taking any money or giving any money to a disqualified person from property held in a qualified retirement account is a prohibited transaction.
It has to be paid to an unrelated third party.
A disqualified person in general, is the account holder/owner of the solo 401k or self directed IRA and direct family members like children, parents, spouses, and grandparents.
Uncles, aunts, and stepchildren do not fall under the definition of a disqualified person from the IRS.
This article gives several examples of what constitutes prohibited transactions in a solo 401k for disqualified persons of the solo 401k.
When it comes to purchasing or investing in real estate with the use of a retirement account, the type of property and its use is what matters most.
If you want to buy a home that you can live in and use as your residence, it is best to use your employer sponsored 401k, traditional IRA, or Simple IRA.
If you want to buy a property that will be used strictly for investment purposes and cash flow it is best to use either a Solo 401k or a self directed IRA.
Either way, you have to be aware of the rules and restrictions for each account in regards to real estate.
If would like to learn about additional investments you can have in your retirement accounts for long term investing, we invite you to learn more about our investing course.
Our investing course was created to help others learn how to invest in the stock market without feeling like they are gambling their hard earned money.
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Nadia is a Financial Independence Coach from New York City. She holds a B.A from Columbia University and worked 13+ years in Investment Banking and Financial Services. She is an entrepreneur, investor, and partner at Wealth Twins LLC. She reached Financial Independence in her 30’s and is passionate about showing others how to achieve the same.