Posted about 2 years ago

How to Add Downside Protection to Your Retirement with Real Estate

Downside protection with real estate retirement investments

“Risk comes from not knowing what you’re doing.” ~ Warren Buffet

Unlike the good old days when Uncle Bob had a pension to live on, a majority of the current working households won’t have a pension to support their retirement. As a matter of fact, one in every three Americans hasn’t saved anything for retirement.

If you do not fall into that category, you’re already on the right path. Here is a question for you:

How do you protect your retirement portfolio from market movements?

A portfolio relying heavily on equities is likely to move with every stock market movement. The key is to diversify your retirement funds and choose asset classes that offer downside protection.

If you own a self-directed individual retirement account or truly self-directed Solo 401k plan, real estate could be a potential addition to your retirement portfolio. As a matter of fact, it could hedge your retirement funds from any market movements.

Let us discuss, briefly, the retirement plans that allow real estate investments.

What is a self-directed IRA?

In simple words, it is a qualified individual retirement account that offers investment discretion, hence the name self-directed. According to the current IRS guidelines, you can contribute up to $6,500 annually to this account. A self-directed individual retirement account allows investments in non-traditional assets.

What is a self-directed Solo 401k account?

It is a qualified retirement account for self-employed professionals and owner-only businesses. You are required to have legitimate self-employment activity and absence of full-time employees to be eligible for the plan.

Unlike a self-directed IRA, it allows contributions of up to $61,000 per participant in 2018 (double this for husband and wife), helping you accumulate retirement funds quickly. Further, it allows alternative investments such as real estate, private equity, tax liens/deeds, private lending, mortgage notes, precious metals, and conventional stock/bond investments.

Related Article:  How to choose a self-directed retirement plan for your future

4 Real estate investments to add to your portfolio

  • Rental properties: If you’re an active real estate investor or have a decent understanding of the industry, buying a rental property is your first option. You can choose a residential or commercial rental property. Further, if you want to diversify among types of real estate properties, you can invest in raw land, single-family houses, duplex/triplex, small or large apartments, mobile homes, and even parking lots. The key is to understand the niche properly before investing.
  • Mortgage notes: For an average small business owner or self-employed professional, handling the daily responsibilities involved in property management could be a challenge. Mortgage notes or paper mortgage present the ideal choice for them. You can purchase a mortgage note backed by a decent property, although make sure to verify the current condition of the property. They offer a consistent cash flow while ensuring minimum hassles. It is best to choose a secured note and check the borrower’s profile upfront.
  • REITs/Note Funds: If you’re planning to add real estate to your portfolio while ensuring enough liquidity, investing in real estate backed note funds and real estate investment trusts is an alternative. They offer somewhat similar liquidity as that of other equity products, although some funds may have a lock-in period in place. In the case of real estate investment trusts (REITs), they are traded just like other publically traded companies. At the same time, REITs are required to distribute at least 90% of their taxable income to their shareholders in the form of dividends.
  • Tax liens/deeds: If you are targeting passive real estate income, tax liens and tax deeds offer another opportunity. The state or local tax authorities put a lien on the property when its owner fails to pay property taxes. There are some other types of liens including income tax liens, judgment liens, child support or alimony liens, mechanics lien, and even divorce liens. However, if you’re new to the realm of real estate investing, be cautious when researching the property backing the note and find out its actual returns.

Related Article: How to achieve financial independence with your small business

3 Things to know before using a Solo 401k for investing in real estate

  • Use of non-recourse loans: If you’re short on funds when buying a property for your self-directed Solo 401k plan, the IRS allows the use of non-recourse financing. While most conventional banks and institutional lenders do not offer such financing, the market has several lenders ready to finance these deals. And unlike with a self-directed IRA leveraged property in a Solo 401k will not trigger Unrelated Business Income Tax (UBIT).
  • Prohibited transactions: If you’re going to use your self-directed Solo 401k plan for real estate investing, be aware of prohibited transactions. The IRS has put up detailed instructions, discussing prohibited transactions. Make sure that you never involve yourself in any prohibited transactions or involve any disqualified persons in any of your deals.
  • Use of investment income: Above everything else, you cannot benefit directly from your retirement plan investments. Any income generated by your retirement investments should go back to your retirement plan only. Further, any expenses involved in the maintenance of these investments should go directly from your retirement plan.

Do you have a self-directed retirement account? 

Have you been successful investing your retirement funds? Looking for better returns? 

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Comments (2)

  1. Hello Dmitry, your article is a good overview. I've learned a lot reading your articles and posts on Sense Financial's website. Thank you!

    I have a question. You mentioned purchasing real estate in a Solo 401K, and getting a loan, the loan will need to be a non-recourse loan. 
    "And unlike with a self-directed IRA the income leveraged property in a Solo 401k using a non-recourse loan trigger Unrelated Business Income Tax (UBIT), allowing you to keep investing more." 

    The wording is a little confusing. I believe the Solo 401K won't trigger UBIT, where a self-directed IRA could. Which is one of the benefits of a Solo 401K if you are able to meet the requirements. Is this correct?


    1. Hello Sharon, I'm glad you found the article useful!

      Your understanding of UBIT implications is correct. If you buy investment property in your Solo 401k plan and use non-recourse financing it won't trigger UBIT, where SD IRA would. Thanks for catching this typo.