Alternative strategies for retirement are growing in popularity, and for good reason. More and more Americans are realizing that the traditional way to save for retirement is outdated, broken, and ineffective. Buying real estate investments is a great way to exponentially grow your wealth and save for retirement.
To help you determine if buying rental properties in a retirement account is right for you, we’re going to run through some of the pros and cons, and the things you need to consider as you’re building out your retirement plan. Click play to learn the pros and cons of using real estate in your retirement plan!
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The pros:
- Buying real estate in a tax favored account offers more freedom and more control than traditional retirement accounts can provide. Using a plan like a self-directed IRA allows you to buy a wide variety of asset types, including real estate investments. Unlike a traditional retirement account such as a 401k, a self-directed IRA allows you the freedom to choose the specific investments you want in your portfolio.
- Certain accounts allow you to create tax-free growth on your real estate investments. If you’re using a tax-advantaged account such as a self-directed IRA to buy rental properties, all of the income you earn inside that account grows tax free.
- Real estate investments offer a higher level of security than traditional investment types. A stock-based retirement plan leaves your funds vulnerable to the ups and downs of the stock market. But when you have rental properties in your retirement plan, you own a tangible asset that will only appreciate in value and is protected from the volatility of the market. It’s not up for debate, real estate is simply more predictable and stable than other asset types, and because it’s not tied to stock market cycles, you can expect more security in your retirement account.
- You have the potential to earn higher returns when you invest in real estate than you would via other retirement strategies. Real estate is the number one way to build wealth, so combining its powers with the tax-shelter of a retirement plan, the potential is unmatched. A traditional retirement account gives you limited earning potential, but with real estate you have the opportunity for double digit returns.
The cons:
- Buying real estate for your retirement means putting off the benefits of cash flow that rental real estate provides. When you buy real estate investments inside of a tax-favored account like a self-directed IRA, all your rental income is locked inside the retirement account. If you are hoping to somehow earn or divide up the cash flow, you won’t be able to do this inside of a self-directed account.
- Tax-advantaged accounts must follow strict rules and regulations. To compensate for the tax-sheltered gains you can receive inside of your account, you’re going to have to uphold your end of the deal. The IRS has a lot of requirements on how the funds inside your retirement account must be handled. I’m not going to get into the specifics in this video, but it’s important that you understand these rules. To me, the tax benefits are worth it, but be sure to consider all the rules like prohibited transactions before you commit to buying real estate inside your retirement account.
- Buying real estate inside a retirement account takes away your ability to be hands-on with your property. Depending on your personality type and preferred strategy, this may not be a “con” for you, but it’s something to consider. While in many ways you have more control with a self-directed IRA, there are some ways in which you actually have LESS control with the investment. The IRS prohibits sweat equity, meaning you’re not able to do any work on your property. Your retirement account itself must hire and pay someone to do any repairs, and your custodian will facilitate the transaction. If you’re the kind of investor that likes to do-it-yourself, you may want to reconsider buying rental properties inside of a retirement account.
If you have questions about building out a retirement plan with rental properties, come over to our website and schedule a free 30-minute call with our team at morrisinvest.com. Our portfolio managers are experts in the nuances of buying real estate inside of a self-directed IRA, and we’d be happy to help you develop an investing plan that works for you.
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DISCLAIMER: I am not a financial adviser. I only express my opinion based on my experience. Your experience may be different. These videos are for educational and inspirational purposes only. Investing of any kind involves risk. While it is possible to minimize risk, your investments are solely your responsibility. It is imperative that you conduct your own research. There is no guarantee of gains or losses on investments.
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FAQs
Some of the considerations to keep in mind with a 401(k) include:
- Pro: You can place funds into the plan every year.
- Con: You might not be able to save enough.
- Pro: Employers might add to the account.
- Con: Contributions from employers might be minimal.
- Pro: Maintaining the account can be simple.
Investing in real estate can be a good idea if done thoughtfully and strategically. It offers the potential for steady income, capital appreciation and tax benefits. However, it's not without its challenges, including high initial costs, property management responsibilities and market risks.
Should you include real estate in your retirement plan? ›
You might consider investing in real estate if you're facing retirement and short of funds. Income property "can be an important bridge to retirement for those without quite enough to retire in the traditional sense," says Jeff Camarda, a real estate investor and CEO of Jacksonville, Fla.
What are the pros and cons of investing in real estate vs stocks? ›
Buying stocks on debt is known as margin investing, which can be risky. There's potential to reap tax benefits. Real estate investing comes with the potential for numerous tax breaks, including deductions for the cost of maintenance, depreciation, mortgage interest and property taxes, to name a few.
What are the pros and cons of investing? ›
Investing in stocks offers the potential for substantial returns, income through dividends and portfolio diversification. However, it also comes with risks, including market volatility, tax bills as well as the need for time and expertise.
What are 5 cons of investing? ›
While there are some great reasons to invest in the stock market, there are also some downsides to consider before you get started.
- Risk of Loss. There's no guarantee you'll earn a positive return in the stock market. ...
- The Allure of Big Returns Can Be Tempting. ...
- Gains Are Taxed. ...
- It Can Be Hard to Cut Your Losses.
Liquidity risk
Investors consider real estate investments illiquid because they cannot easily convert them into cash. Selling a property can take months or even years, depending on market conditions. This lack of liquidity can be a problem if you need quick access to your capital or want to diversify your investments.
What is one advantage of investing in real estate? ›
The benefits of investing in real estate include passive income, stable cash flow, tax advantages, diversification, and leverage. Real estate investment trusts (REITs) offer a way to invest in real estate without having to own, operate, or finance properties.
What are the disadvantages of direct real estate investments? ›
Lack of Liquidity: One of the major drawbacks of real estate investing is its lack of liquidity compared to other asset classes. Unlike stocks or bonds, which can be bought and sold quickly, selling a property can be a time-consuming process that may take weeks, months, or even longer.
What is the 4 rule retirement real estate? ›
The 4% rule in retirement planning is used to determine how much you should withdraw from your retirement account each year. Basically, the idea is to give yourself a healthy stream of income, while maintaining an active account balance during retirement.
Some of the asset allocation strategies and risk management techniques that you can use for your real estate allocation are: The rule of thumb: A common rule of thumb for real estate allocation is to invest no more than 25% to 40% of your net worth in real estate, including your home.
How can real estate investments be used to supplement your retirement income? ›
BENEFITS OF OWNING RENTAL PROPERTY IN RETIREMENT
However, over time, you'll gain equity in the home as the rental income pays your mortgage, taxes, and fees. As a result, the home will generate positive monthly cash flow. Over the years, you add to your portfolio by buying more properties repeating the process.
What's one of the biggest disadvantages of real estate as an investment? ›
Lack of Liquidity
It's easy to sell stocks if you need money or just want to cash out but that's not usually the case with real estate investments. You could end up selling below market or at a loss because of the lack of liquidity if you need to unload your property quickly.
Which is riskier stocks or real estate? ›
For instance, investing in the stock market tends to be more volatile than real estate. However, purchasing a rental property requires a significant upfront investment and may be subject to unforeseen costs.
Is it better to save or invest in real estate? ›
Rates for high-yield savings accounts fluctuate and can offer a higher return rate than traditional savings. Real estate investments often offer consistent returns over time. That could mean that one occasionally outperforms the other. But you also have to consider tax implications.
What are the pros and cons of starting to plan for retirement early? ›
Pros of retiring early include health benefits, opportunities to travel, and starting a new career or business venture. Cons of retiring early include a strain on savings, and a depressing effect on mental health.
What is the $1000 a month rule for retirement? ›
According to the $1,000 per month rule, retirees can receive $1,000 per month if they withdraw 5% annually for every $240,000 they have set aside. For example, if you aim to take out $2,000 per month, you'll need to set aside $480,000. For $3,000 per month, you would need to save $720,000, and so on.
What are the pros and cons of 401k? ›
Pros and cons
- Greater flexibility in contributions.
- Employees may contribute more to this plan than under IRA plans.
- Good plan if cash flow is an issue.
- Optional participant loans and hardship withdrawals add flexibility for employees.
- Administrative costs may be higher than under more basic arrangements.
Some of the advantages of mutual funds include advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing, while disadvantages include high expense ratios and sales charges, management abuses, tax inefficiency, and poor trade execution.
