There is no question that those with ready cash or access to affordable financing have an easier path to success as real estate investors than those who do not. Because cash is king in the investment industry and financing for real estate investment can be tough to come by, many new investors are choosing to use their 401(k)s to invest in properties in the Chicago market. 

chicago real estate, 401k

The use of 401 (k)s as a real estate investment tool is on the rise. This is partly due to a stagnant stock market and low yields on traditionally safe investments such as bonds that 401(k) managers favor.

But is that a good idea?

As with most questions concerning real estate investment, the answer is: It depends.

For many investors, a 401(k) retirement fund is the largest single account they possess, but it is one they do not have unlimited access to. Therein lays the problem. In order to use a 401(k) as an investment vehicle, it is necessary to engage in a bit of creative shuffling or pay severe early withdrawal penalties

There are three means to use your 401(k) to fund a real estate investment: cashing out, borrowing from your 401(k) and rolling over to a self-directed IRA.  Cashing out your 401(k) is a drastic measure and comes with severe penalties. For that reason, we will not discuss that option here.

Borrowing from Your 401(k)

In some cases, you can borrow from your 401(k) with no penalty. In order to borrow against your 401(k) your employer must have a plan that allows that option, but if you have that type of plan, it can be a great tool in your investment toolbox.

When you borrow from your 401(k), you can then use that money to invest in real estate with no penalty. Normally, you have up to five years to pay back the loan. There is no cap to the amount you can borrow, and interest is of no real concern because you are in reality just shifting money from one account to the other. There is one major drawback. If you lose your job, you will be required to pay the outstanding balance of the loan within 60 days or face income tax and other penalties on the balance amount.

Rolling Into a Self-Directed IRA

Today, you have the option to roll your 401(k) into a self-directed IRA. With a self-directed IRA, you gain the option to invest in a host of assets – including real estate – that are not normally available with a traditional 401(k). There are a few drawbacks to this method of investing Chicago real estate.

  • You do not have access to any rents collected. All revenue must go back into the IRA.
  • You cannot deduct any property depreciation on your tax return.
  • You cannot write off any losses.
  • You are still bound by the $5,000 per year contribution limit to your IRA. That makes it impossible to add additional funds to cover large expenses like renovations. All money spent on a property must come from the IRA.
  • You cannot use the property for personal use. This restriction includes family members with the exception of siblings.

There are other restrictions, and a qualified financial advisor will be able to elaborate on these restrictions and illustrate exactly how they apply to your unique situation.

Using your 401(k) as seed money for real estate investing is certainly a way to get a head start in the industry, but it does come at a cost. It’s not a step to be taken lightly, and be sure to speak with your financial advisor before you make any long term decisions that will affect your future retirement.