[Editor's Note: Today's post originally ran as one of my regular columns for ACEPNow, but has had some modifications.]
I want to invest in real estate, but all of my retirement money is in retirement accounts like 401(k)s and Roth IRAs. What are my options?
Retirement accounts are, in many respects, a physician’s delight. These accounts provide tax-protected growth, which allows for higher returns, enlarging your retirement nest egg. They also facilitate easy estate planning and excellent asset protection in most states. Doctors have sufficient income to be able to maximize these advantages and also generally have more tax-protected accounts available to them, including 401(k)s, 403(b)s, 457(b)s, 401(a)s, SEP-IRAs, individual 401(k)s, profit-sharing plans, defined benefit/cash balance plans, health savings accounts (HSAs), and backdoor Roth individual retirement arrangements (IRAs). They are also more likely than most to benefit from the tax rate arbitrage available by deferring taxes from their highly-taxed peak earnings years to what is usually a much lower marginal tax rate during retirement.
These advantages should make a doctor very hesitant to pass on a retirement account contribution, much less actually withdraw money from an account before they have to in order to pay living expenses or meet federally mandated required minimum distributions beginning at age 72. In fact, any time I hear of an “adviser” trying to talk a physician investor into withdrawing money from a retirement account, my first assumption is that the adviser is selling something to a physician inappropriately.
How to Invest in Real Estate with Retirement Accounts
Doctors are increasingly interested in real estate investing these days, especially after seeing just how fragile their earned income could be during the recent COVID-19–associated economic downturn. Passive income seems to be the cry of the day. Real estate has always been an attractive asset class, offering high returns, low correlation with both stocks and bonds, easy leverage, and some unique tax advantages (primarily depreciation). The fact that a large portion of its return comes in the form of regular income does not hurt either. I invest in real estate and think any doctor interested in it should include it in their portfolio.
However, a lot of doctors have the vast majority or even all of their long-term investment money inside retirement accounts or perhaps are not maxing out these accounts. How can they invest in real estate?
First, realize that there are many different ways to invest in real estate. Although most people think being a real estate investor means buying the house down the street and renting it out, there are many other ways to do it that often provide much more diversification and require far less hassle.
REITs
One of the easiest ways to invest in real estate is simply to invest in publicly traded real estate companies, either directly or through a mutual fund. Many of these companies are real estate investment trusts (REITs). One of the most popular mutual funds is the low-cost Vanguard REIT Index Fund, which essentially buys all of the publicly-traded REITs in the United States. This fund, or another similar to it, is likely available in your 401(k) and is certainly available in your Roth IRA at the best mutual fund companies, such as Vanguard, Fidelity, or Charles Schwab. These funds are also available as exchange-traded funds that can be purchased at any brokerage firm, whether inside or outside a retirement account.
Syndications and Private Real Estate Funds
There are also private real estate investments, including syndications (where many investors combine funds to buy one large property, such as an apartment complex) and private funds. These investments are typically only available to accredited investors and offer a few tax advantages over a REIT mutual fund.
Using a Self-Directed i401k or IRA
Primarily, syndications and funds pass through the depreciation from the property to shield some or all of its income from taxation. However, these investments can be purchased inside a retirement account—the account simply has to be a “self-directed” individual 401(k) or IRA. There are even self-directed HSAs these days. While these do charge more than you would pay for a non-self-directed account at a good mutual fund company or brokerage, the benefit may be worth the extra cost to you.
Can you just buy the house down the street with your self-directed IRA? Yes. Just remember that every dollar going into that house has to come from the IRA and every dollar coming out of it must go to the IRA. Unfortunately, if you have a mortgage on that house, you will run into the unrelated business income tax if using an IRA. Using a self-directed individual 401(k), available to independent contractor physicians, will avoid that tax.
A particularly good candidate for real estate investing inside a self-directed IRA or 401(k) is a private debt fund for accredited investors such as those offered by DLP Capital Partners, one of our current sponsors and one of my favorite Real Estate Company Partners. They have one equity and three debt funds with lowered $100k minimums (normally $250K minimum) for the White Coat Investor family. The equity fund (they call it DLP Housing Fund) passes through depreciation and is reasonably tax-efficient. The debt options (DLP Lending Fund and the DLP Notes Fund) are very tax-inefficient because the entire double-digit (past and projected, not guaranteed) return, great as it is, is paid out each year as fully taxable income, making these funds great holdings for a self-directed 401(k). If you want to add private real estate to your self-directed retirement account, consider investing alongside me in the DLP Lending Fund.
401K Loans
Obviously, the cleanest option, if you want to invest directly in real estate, is simply doing it outside of your retirement accounts. If you work a little more or spend a little less, you may be able to max out those retirement accounts and still have something left over to invest in real estate. Another option is to use a 401(k) loan for the down payment on your property. You can borrow the lesser of $50,000 or 50% of the value in the 401(k) for up to five years. The interest you pay will go back into your 401(k) account, although you will miss out on the returns of whatever that money would have been invested in within the 401(k). Keep in mind that if you quit or are fired, that loan will have to be paid back by tax day (including extensions) for the year you separated from the employer or you will owe both taxes and penalties on it.
Penalties for Early Withdrawals
Real estate can be a great investment option. It can provide solid returns and help diversify a stock and bond portfolio. It is best if your real estate investment represents an addition to your retirement account contributions rather than in place of them. You can also invest in real estate within your retirement accounts as long as you follow the applicable rules.
How are you using retirement accounts to invest in real estate? Comment below!
Is there such a thing as a Self Directed Roth IRA? I’ve been maxing out my mega backdoor for a year, and it’s already grown quite a bit. If I keep maxing it out for a few years, I might have a significant chunk that I might be interested in doing private real estate with. (I’m still on the fence about whether I *really* want to invest in private real estate though, I like me some cheap index funds, but it looks like an interesting thing, specially if returns are much higher)
Sure.
It’s so true that most people assume that real estate investing is limited to just active investing via rental properties. There are so many other options!
While cash flowing rentals are the best option in my opinion, investing in something as simple as REITs is a great way to get exposure like you mention!
The only downside of investing via self directed accounts that I can think of is the limitation of (wisely and cautiously) using leverage to access last equity and expand your portfolio. (In addition to the obvious downside of not having access to the money until at least 59.5 years old). But can be a good option for many.
Great post as always!
You can use leverage. However, in a SD IRA it’ll cause some UBIT to occur.
QUESTION: I have a solo 401K with Vanguard. I actually have a phone appt with DLP today. I am interested in investing in private REITs/hard money lending.
How do I set up for example the DLP Lending fund through my Vanguard solo 401? I am assuming I would have to open a second solo 401k “self directed ” for this.
1. Can you have two solo 401Ks–so one with Vanguard and one with another company that is self directed(for private REITs/hard money lending)?
2. What companies can you open a self directed solo 401K with?
3. Am I able to transfer a part of my money from Vanguard solo to this new self directed solo for investing?
thanks WCI! I know we would love a post dedicated to this
1. A cookie-cutter Vanguard solo 401k isn’t going to allow that. You will first need to open a self-directed individual 401k somewhere else. These folks can help:
https://www.whitecoatinvestor.com/retirementaccounts/
2. see above
3. Probably easiest to move the whole thing.
What about putting a portion of what could be called an agricultural business into your Self-Directed IRA? Essentially a “crowd funded” tomato farm. What I am wondering about is UBTI on debt that the managers might take out? My understanding is that just because you only own a piece of the pie doesn’t negate you from having to account for your piece of every business expense or income that comes from the farm. Any resource that covers this further?
Your understanding sounds correct to me.
Not sure what resource to give you.
I’d like to pose a corollary question. How do you recommend that a high worth retiree with no salary or wage income and most of his or her assets tied up in tax deferred and tax free accounts purchase real estate, e.g., a second home?
Use what you have. You have four options:
1) Get a mortgage (probably tough without regular income)
2) Borrow $50K against the 401(k) if you have one (probably don’t as you probably rolled them into IRAs)
3) Withdraw from tax-deferred money and pay the taxes
4) Withdraw from tax-free money
I’d probably do a combo of 3 and 4. 3 up to the top of a bracket (your current or one above maybe) and then 4 for the rest. I’d use any taxable money I had too.
I was thinking of taking a ten of fifteen year home equity loan on our principal residence, which we own free and clear, and then pay it back monthly with our tax deferred assets (tIRAs). What do you think about that?
I don’t think it’s crazy. I’m kind of anti-debt so I probably wouldn’t do it, but I can understand why someone would.
I am a University employee that uses TIAA for its retirement account, 403b and 457b.
TIAA does allow you to set up a self-directed brokerage account. But I can’t tell if once it is set up that I will be able to direct it to “anything the IRS allows” or if it is only a “cookie cutter” self directed account.
Do you know if retirement account with TIAA would typically allow for investment with DLP?
From an asset allocation perspective of my total investments, I can put 100K into DLP and be comfortable with the risk and diversification. But my individual retirement accounts don’t amount to 100K minimum. My thinking is that it is easier to reallocate some savings within TIAA without triggering taxes on the sales and then it would also be better to have the real estate investment through a retirement account. Otherwise, I have to build cash over what would likely be a 6-12 month period, without directing to funds according to my usual asset allocation.
Thanks!
No, I would not expect that.
You are probably stuck investing in taxable or not at all if you really want to invest in a private real estate fund like DLP.
I wouldn’t pass up a retirement account contribution to invest in taxable.
Thinking of using either Traditional IRA or Roth IRA to fund DLP Lending fund. Any thoughts which one is better? If Roth, do all the distributions from DLP retain the Roth tax-free status?
As a general rule, $100K in a Roth IRA is more money than $100K in a traditional IRA, so if you don’t tax adjust, Roth is better. If you do, then it doesn’t matter.
Yes, all distributions go back into the IRA or Roth IRA and are not taxed as they grow. That’s the point of having the investment in the account.
Great experience with DLP! Really appreciate their customer focus. Off and running with the Lending fund using a Roth. Now looking at the Housing fund. Thanks WCI.
You’re welcome! Thanks for the feedback.
Thank you for the great info you provide!
I’m now starting a Roth IRA (via back door thanks to you). I hold the Vanguard TSM and total international, as well as some bond funds in my 401k. I don’t have real estate in my portfolio. Is there a benefit to having a REIT mutual fund in my Roth vs. in a taxable account?
Generally REITs are considered to be fairly tax-inefficient, so they’re best in a tax-protected account like a Roth IRA.
https://www.whitecoatinvestor.com/asset-location/
What are your thoughts on opening a SDIRA for investing in a private lending fund if it means forfeiting the opportunity for tax free back door roth contribution due to the pro-rata rules. I am eligible to rollover a portion (150K, currently invested in bonds with a very low current and projected return for the next few years) of my 401K to a SDIRA. If I invest that 150K in a private lending fund with double digit returns in a SDIRA, it seems to me that a ~$2200 tax on the annual back door roth contribution would be a reasonable price to pay for this.
It’s not crazy. A BD Roth isn’t worth THAT much.
I wouldn’t expect double digit returns out of a lending fund either. 6-11% maybe, but could easily just be high single digits even if all goes well.
I don’t think I’d keep doing BD Roths if I did that.
Another option to consider is to create a SD Roth IRA via a Roth conversion. Perhaps you pay $50K in taxes to do it, but then you have a $150K Roth IRA invested in that fund and you can still do BD Roths each year to add to it.
I’m interested in investing in a private REIT / Fund inside of a SD-IRA but, currently have the IRA through Vanguard which I believe doesn’t allow that. Do you have any preferred / recommended companies with low fees to setup the SD-IRA though?
Secondly when RMD time hits how does that work if you have a SD-IRA and its tied up in real estate? I’m a ways away from that but, curious on how that works.
Thanks for all you do!
Yea, you can’t do it through Vanguard. There are dozens of companies that will do it for a fee. Our recommended list for this topic is found here:
https://www.whitecoatinvestor.com/retirementaccounts/
There must not be much money in it though (value of a customer x number of customers) since we can’t keep very many advertisers on that list even with rock bottom prices.