You might have wondered whether it’s possible to use a retirement plan for making real estate investments. Some people will tell you that you can’t do this. Actually, you can.
But should you? That’s a different question and the answer depends on your personal circumstances. I’m not giving any investment advice, but if you’ve already made the choice to give this serious consideration, here are a few things that you should understand.
- Know Your Options
- Self-Directed IRAs
- SDIRAs Are Not Just For Real Estate
- Watch Out For UBIT
- Other QRP Options
Whatever you decide regarding your investments, I think that putting your retirement savings to work for you now should be good for your long-term prospects — so long as you invest wisely.
Know Your Options
Most people are used to the idea of getting a 401(k) from their employer. What most might not know is that a 401(k) is an example of a Qualified Retirement Plan or QRP.
QRPs are recognized by the IRS and have special tax advantages that can boost your savings, such as allowing taxes to be deferred which gives you more money to invest today.
A 401(k) is just one type of QRP, there are many others, like 403 (b), SEP, and SIMPLE plans just to name a few. There are also other types of retirement plans that aren’t offered by your employer. For example, you have probably heard of an Individual Retirement Account or IRA. This is another retirement savings option that also has special tax advantages.
Most 401(k)s and IRAs are run by a custodian or trustee, which is a regulated company that manages the account for you at arm’s length.
Custodians have defined offerings such as stocks, bonds, mutual funds, ETFs, and other traditional investments. These investments are convenient but the custodian can, and often do, limit the options that are available. This means that, as an investor, you don’t have a great deal of control. For example, if there were a specific stock you wanted to buy, your custodian usually wouldn’t allow you to do that.
As you might expect, a custodian doesn’t offer their services for free. They have their fees and their processes for running the relationship. It’s all buried in the fine print, but most of us rarely have the time to dig through all of that to fully understand what they’re getting into.
The things to keep in mind with these traditional providers:
- Investment options are limited to the funds that the custodian offers.
- You have to pay fees for the service.
- Fees aren’t always clear and easy to understand.
Savvy investors often want more control and clarity — and that’s where Self-Directed IRAs come in.
Instead of settling for what custodians normally offer, you can take matters into your own hands and set up a retirement plan called a Self-Directed IRA (SDIRA). This is an account that can hold a variety of alternative investments normally unavailable through a 401(k) or IRA.
This often means rolling over your funds into this new plan from your existing IRA or 401(k) from a previous job (note: not your current job).
For compliance reasons, a SDIRA still requires a custodian or trustee, but the investments are directed by you, the account holder (hence “self-directed”). With a SDIRA, you provide instructions to your custodian to act on your behalf, which offers you much more control than standard IRAs.
It’s important that your SDIRA is set up correctly, or else you stand to lose all the tax benefits, so it’s essential to do this work through an entity with a strong track record that knows what they’re doing. This isn’t just a simple internet hack that anyone could use — you need to do it right or not at all.
With a SDIRA in place, you could instruct your custodian that you have a real estate investment to make, such as investing in a syndication. Your custodian’s responsibility is then to keep all transactions at arm’s length from you, so you don’t get paid directly. Any returns from such investment deals will go straight into your SDIRA rather than through you.
SDIRAs Are Not Just For Real Estate
I should say that while my interest is in real estate, that’s not the only type of investment you could make using a SDIRA. You could, for example, invest in other things such as single stocks, mutual funds, or other things like Broadway musicals (one of my passions).
On the flip side, there are also some areas of investing that are specifically not allowed via this method, such as collections. So, if you thought about building a priceless set of baseball cards from every World Series, that’s not happening through this route.
When I was learning about investments (you can read all about it in my book, Backstage Guide to Real Estate), I discovered SDIRAs and rolled over some of my retirement funds into one — so I’ve been there and done this for real.
Watch Out For UBIT
SDIRAs are great because of the enhanced direction they allow you, but they come with an important warning, which I learned through hard (expensive!) experience. Here it is:
If you use a SDIRA to buy a property, you may be subject to Unrelated Business Income Tax (UBIT).
UBIT is a tax that is imposed on a tax-exempt organization that is not related to the tax-exempt purpose of that organization. If you invest in a property that utilizes debt (a mortgage), then you may be subject to tax on the gains attributed to that mortgage.
For example, let’s say that you get a 75% mortgage on a property. Five years later you sell it and make a nice profit. Thanks to UBIT, 75% of your profit could be subject to tax. Ouch!
If you’re not ready for that — and I wasn’t when this happened the first time — then the profits you thought you were going to make may be way off what actually ends up in your account.
Other QRP Options
It’s possible to take things a step further by creating a different type of QRP that isn’t a SDIRA. If you work with the right people, they can set it up and keep it within all relevant rules, and you may be able to create a QRP that is not subject to UBIT.
As a regular reminder, I am not a lawyer and I can’t set up these plans for you, so I’m just telling you of options that might be available if you’ve already decided that you want to use your retirement funds to invest in real estate.
Don’t forget to check out the Picheny Investors Club where you can learn about passive real estate opportunities that can make your money work hard for you right now and all the way through to a happy retirement.