Using a 401K for Investment Property: A How-To

Most Americans state that building wealth for the future is a major career goal. This ethos of “working to live” instead of “living to work” prompts many folks to start setting capital aside for a comfortable retirement. While not many want to work forever, most people do look forward to living well, especially in their golden years. That’s why this blog discusses using a 401(k) for investment property.

It should come as no surprise that investment properties offer enormous potential value to investors because they add another avenue for stable returns to their portfolios. What may surprise you is that eligible investors may be able to invest in real property by using funds currently held in a 401(k).

If you’re looking for ways to diversify your portfolio, I’ve got the details you need to know to use money in a 401(k) to purchase real estate investments.

401(k)s Explained

For decades, 401(k)s have replaced traditional pensions as the most common financial vehicle for retirement savings. Recent factors like market volatility, inflation, withdrawal limits, and accompanying taxes, however, have started raising questions about whether investments held in a 401(k) alone can sustain a suitable quality of retired life.

Definition

Typically employer-sponsored, 401(k)s are tax-advantaged retirement plans through which companies often match a certain percentage of employee contributions. Employees can choose a flat dollar amount or percentage of their gross salary to contribute from every paycheck. All contributions are tax-deductible, but withdrawals are subject to taxes.

This readily accessible option gives even the least financially savvy individual an opportunity to invest in funds with limited hands-on involvement. With a standard 401(k), you can just set it and forget it!

Limitations

You might notice some drawbacks in the details, however, that could make a 401(k) less enticing as a singular retirement option.

Chief among them is the limit of options you have over how to invest your money after it’s contributed. The capital in your 401(k) is essentially locked in place — usually 401(k) participants must select from a pre-set portfolio of stocks, bonds, and mutual funds — until you make a withdrawal. That means even if you have hundreds of thousands of dollars invested, you have little choice about which individual funds your money goes into.

In addition, it could take years before you are vested in your employer’s contributions. Though the length of time varies with individual plans, most employees are fully vested within either 3 or 6 years, maximum. You may risk forfeiting any employer contributions if you leave a company before you’re vested. If this occurs, it could significantly impact your account balances and funds invested to date.

Moreover, as market forces continue to shift in extremes and inflation reaches decades-high levels, your current 401(k) investments may simply not be enough to provide the life you’ve imagined when it’s time to retire and reap the rewards of your hard work.

In short, while 401(k)s do allow you to contribute easily to a retirement savings account without worrying about closely managing the funds, they do have some shortcomings, which can include:

• Limited options for investment once the funds have been contributed.
• Possible delay of several years before you become vested.
• IRS limits on yearly contributions.
• Tax penalties upon early withdrawal. 
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There are ways to transfer your money out of its current 401(k) vehicle to explore more options to invest your money. It all starts with what is known as a 401(k) rollover.

Rolling Over a 401(k) 

A 401(k) rollover involves a direct transfer of the funds from your current 401(k) plan to an individual retirement account (IRA). There are some intricacies here that we recommend you speak to your investment advisor about. If a rollover is right for you, funds placed in a self-directed IRA may be eligible for various alternative investments, including real estate.

The table below lists some of the key differences between a 401(k) and a self-directed IRA.

The key factor when comparing 401(k)s with self-directed IRAs regarding investments is that you have a lot more options with a self-directed IRA because you generally have access and can control what you do with the funds.

This article and the grid above contain only summary information about 401(k)s and self-directed IRAs. Be sure to talk to your financial advisor and your tax professional to ensure you understand these investment vehicles, rules, and the limitations that may apply.

How to Use 401(k) Assets for an Investment Property

Earlier in this article, we mentioned real estate investing options, but we had to save discussing the nuts and bolts until after the 401(k)-vs.-self-directed-IRA explanation. That’s because while you generally will not have the ability to invest 401(k) funds for direct real estate investing, you can gain this ability by using a self-directed IRA.

So, you’ve set aside funds from your 401(k) and rolled them into a self-directed IRA. Now your money isn’t restricted to traditional investments like bonds or stocks and—subject to certain limitations—you can fund a variety of alternative investments, like real estate.

But what are the mechanics of this process, you ask? While the process is a bit involved, we can distill it into a handful of main steps, listed below.

1. Open your self-directed IRA.
2. Roll your funds from your 401(k) into the IRA.
3. Locate your potential investment property.
4. Make an Earnest Money Deposit.
5. Prepare for the escrow process with the title company.
6. Close the purchase of the property.
7. Begin managing the property.
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Now that you have the basic dance steps, there are a few guidelines and caveats you should know about before beginning this process:

• The property must be used solely as an investment property. It cannot be used as a second home, an office for your business, or a home for family members.
• Any revenue generated from the property, like rental income, must be declared as taxable income.
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Armed with all this knowledge, your next step is to use it to start diversifying your investment portfolio. It’s worth noting that taking on an investment property is a huge responsibility, especially for those who are new to the whole real estate investment strategy. As the property manager, you’ll be responsible not only for ensuring the tenants are happy and that the property satisfies legal requirements, but you’ll also manage the taxes and fees that come with your new source of income.

If it sounds like you’re trading away the convenience of “setting and forgetting” your automatic 401(k) contributions, that’s not necessarily the case.

For example, instead of managing a property directly, you could put your money into a real estate investment that’s managed by another party. This allows you to enjoy the benefits of real estate investing without the extra responsibilities of property management. You could give Canyon View Capital a ring to find out what kinds of options we have that will accommodate your self-directed IRA. All it takes is a phone call.

Canyon View Capital Makes Real Estate Investing Simpler

Here at Canyon View Capital, real estate investing is our bread and butter. CVC principals have over 40 years of experience, and now our team manages over $1 billion (aggregated) in real estate properties located across middle America. Our offerings have similarities to other real estate investments but without the burden of property management.

Whether you’re new to real estate investing or an old pro, the CVC team is ready to make real estate investing as easy for you as possible. We can also leverage a depth of pooled knowledge from principals with a broad scope of professional experience.