Best way to invest with my 401K for Investment Property?

Question

I am 64 years old, working and am saving 401K offered my my employer. I'm planning to retire in one year but instead of depending on my 401K as my sole retirement fund, I wanted to buy a rental property to supplement my income. I currently have $475,000 in my 401K (pre-taxed). I am looking to purchase a multi-family house for approximately $275,000 to $300,000. I do not want a mortgage and wanted to use the 401K to pay for the home. I was told by the custodian of the 401K, that I would pay approximately 27% federal taxes at time of withdrawal and at the end of the year city and state taxes. I know the custodian has an interest in keeping the 401K and my be trying to discourage me from cashing out without showing me options.

I was hoping that maybe someone could tell me the best way to use these funds with the minimal loss. Is there any exceptions to withdraw the funds for investment property or ways that I can funnel my money to avoid a huge loss in taxes?

Bernard Reisz · Answer

@John Solotarow You've gotten great info from @Taylor L. and @Brian Eastman. Important to add that you may not live in a house that is owned by your IRA. So long as you're following the rules for IRAs, with the primary one being that the IRA not be used for your current (pre-distribution) personal benefit - you can use an IRA for every real estate asset-class.

Brian Eastman · Answer

@John Solotarow

Taylor is correct.  What you need to evaluate is a self-directed IRA.  Since you are already beyond normal retirement age of 59 1/2, you can continue working and contributing to your employer 401(k), but also have the option to move at least a good majority if not all to another IRA of your choosing.

Your current plan provider does not know about or understand alternative asset investing, as it is not their business, so you got bad information from them (not at all unusual).

With a self-directed plan, you keep the tax-sheltered status of the IRA, but have more investment choices such as a rental property as you describe.  The IRA will own the property, pay for the expenses and receive the income in the same tax-sheltered manner as the plan receives income from stock market investments.   Since you are over age 59 1/2, you can choose to take taxable distributions from the cash flow the rental produces if you like.

There is a good bit of information about self-directed IRA and 401k plans here on BP and several providers that are very knowledgeable participate.  Give one of us a call.

Glenna Wood · Answer

I'm not a pro but will share the steps I took to do this about 8 years ago.

Step 1: Rollover all or part of your 401k to an individual IRA. Your 401k will have their own rules about when you can roll your money out. You'll need to research and find an IRA custodian to accept your rollover into a self directed IRA. BP has more than a few pros on this. Plenty in google. I found that Madison Trust had the best fees for my situation and really good learning and process flowcharts on their web page. There are many custodian choices now and their fees for setup and future transactions vary. Since you want to buy real estate, find a custodian that will allow your SDIRA to hold a checkbook LLC.

Step 2: Setup your LLC in your SDIRA. The custodian will likely have a partner that can do this for you. Fees will not be that different from setting up an LLC out of your IRA. It will include a simple operating agreement and an EIN from the IRS for your LLC. Once it's setup you, as the manager of the LLC owned by your SDIRA, can open a bank account for it. Now you can go buy your real estate and pay the bills for it. If you don't go the checkbook LLC route then the closing docs, checks will be issued by the custodian with their fees for each piece and deed held as "Custodian FBO Your Name IRA acct #" or similar. With checkbook you sign the docs as LLC manager and write the checks and it will be deeded to your LLC.

You have enough in your 401k to buy your property all cash. I personally did not want the headache and extra work to carry debt in my SDIRA. Plus your income to your SDIRA will accumulate faster with no debt.  If I was much younger, I would consider leveraging with debt and dealing with the extra IRS reporting and payments on that.

One more advantage in a checkbook LLC is that you can earn interest on your cash holdings when you are between properties or getting ready to start taking distributions. I didn't find any custodians that offered any interest on the cash in my SDIRA.

The big caution as others have mentioned is that you can gain no personal benefit from the property. You can't rent to a disallowed party. As LLC manager you can sign contracts, write checks to pay the property taxes, repairs, etc but you personally can do nothing to add value to your SDIRA via sweat equity.  So you can hire and pay a guy to mow the lawn but you can't cut a single blade of grass. In researching custodians, some insisted that you need a property manager. Some said not so. IDK which is right and likely depends on the type of RE you invest and how high maintenance your tenants are. But you have to be diligent to follow all the SDIRA rules.

All income goes to the LLC. Your custodian will expect you to provide an annual declaration to them on your LLCs value so they can report to the IRS. If you want cash out of the LLC, you will request (and pay their fee) for a distribution check just like any other IRA. My custodian charges for cash transfers to/from the LLC to the SDIRA then potentially on to you.

Couple of fine points I have not seen discussions about...

1) One custodian said my LLC needs an EIN, another said not needed. I have one. Found it was useful to request the credit agencies to not allow any credit or loan requests to my LLC EIN. All my personal info was stolen from OPM years ago. A few years after my LLC was opened, I was getting collection letters from a third party credit card processing company. My LLC info from the state public records was linked up to my personal stolen SSN and address to run about $20K of fraudulent credit card transactions. Took alot of time to deal with this. Sadly somebody is always trying to steal from you. I had my address as the registered agent for my LLC so they had all the stolen info they needed. IDK if it would have better to pay for a more anonymous registered agent. Really did not anticipate scammers on my IRA.

2) The other topic I never see discussed about SDIRAs is planning for your RMD when you hit 70 1/2. Or planning for liquidation of the LLC if you don't want your "not" money saavy heirs to deal with an inherited SDIRA with an LLC. There will be plenty of sales pitches to set up your SDIRA for RE for you but nobody seems to talk about an orderly way of getting out of it.  As I understand it custodians can only hold your account and cannot provide advice on your investments and planning. So how will you distribute part of your real estate out of your SDIRA to meet your RMD? Guess I need to start a new thread on this as I can't even find google hits on this one.

You will not regret opening a SDIRA just take the time to get educated and do your planning. Good luck to ya!

Jeff Cichocki · Answer

@John Solotarow - There has been some great advice on this one. While no one else seems to have said it this directly, I would suggest that you also explore a Solo 401k as the vehicle that you move your funds into when you retire. There are some significant advantages if it turns out to be the right vehicle for your situation. There is a great book that was written by 3 experts (Dorsi Kuni, Dyches Bodiford & John Hyre) on this topic. I don't get anything for this referal, but if you're interested, you can get a copy of the book here... https://assets101.com/shop/solo-401k/It's a great book. I highly recommend adding it to your collection.

Good luck!

George Blower · Answer

@John Solotarow

Here are some issues to consider in choosing an SDIRA provider:

1. In order to have checkbook control, the IRA account will need to be at a trust company that will allow the IRA to invest in an LLC (where you will be the manager and your IRA will be member - an as manager you will have checkbook access to the LLC bank account). Therefore, you will want to confirm that the trust company allows for investing in an LLC and the associated fees and minimim balance that applies to the IRA account.

2. Confirm that the IRA LLC provider will prepare all of the documents needed to not only form the LLC (articles of organization, SS-4 to obtain an EIN) but also the documents needed by the trust company to process the investment of IRA funds in the LLC.

3. Confirm that the provider has experience with the particular investments in which you intend to invest your retirement funds as you very likely will have questions in terms of the mechanics (e.g. how do you invest in real estate, etc.).

4.  Confirm that the provider has a pristine reputation (e.g. Better Business Bureau reviews, etc.).

5. In addition, if you are self-employed with no full-time employees you may wish to consider opening a Solo 401k instead of a self-directed IRA as it has several advantages over an IRA LLC such as much higher contribution limits, direct checkbook control (i.e. no need to have the account at a speciality trust company), ability to take a 401k loan, exclusion from unrelated debt finance income tax with respect to investment in real estate acquired with non-recourse financing, etc.

In addition, please note if you purchase debt-financed real estate with your IRA, unrelated debt finance income tax should apply to the income attributable to debt-financed real estate held by yourIRA. Of course, you will want to review your specific situation with your tax advisor.

Dmitriy Fomichenko · Answer

@John Solotarow

Keep in mind that if you decide to go the self-directed IRA route, the investment property would be owned by the IRA, not you personally. You won't be allowed to do any work on the property or provide any services to the plan. All income belongs to the IRA and all expenses related to the property must be paid from the IRA. You can take distributions from the IRA as you would normally do from conventional IRA.

Taylor L. · Answer

Look into Self Directed IRAs and Solo 401(k)s. You don't need to distribute the funds to invest in real estate, just change the account type. These accounts have lots of restrictions which you need to know before you use them, so be sure you're up on the rules.Some of my investors use retirement accounts to invest in our syndications. I use a Self Directed IRA to invest in others' syndications, although I will be switching to a Solo 401(k) down the line.

Best way to invest with my 401K for Investment Property?

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