A 401k is an investment savings account that’s sponsored by the employer of the individual who holds the account. Workers are able to make contributions to a 401k account via automatic payroll withholding, which means that the money will automatically be taken out of your paycheck and sent to your 401k account. Depending on the account you have, your employer may match a portion or all of your contributions.
Any money that’s placed into a standard 401k plan isn’t taxed until you withdraw the money, which usually occurs after retirement. If you invest in a Roth 401k plan, your withdrawals could also be tax-free. There are a couple of different types of 401k plans that you should be aware of, which include Roth 401k plans and solo/self-employed plans. A Roth 401k plan is a special type of 401k account that’s funded with your after-tax dollars up to a certain amount. Because the account is funded with after-tax dollars, eventual withdrawals don’t need to be taxed, which is the opposite of how a traditional 401k works. Both account types have their advantages and disadvantages.
Withdrawing From Your 401k
Before you start investing in a 401k, it’s important to understand how these accounts work when it comes to withdrawing from them. For one, anything that you withdraw from a 401k before you reach 59.5 years old will result in a tax penalty of 10 percent, which can make for a substantial reduction in your overall savings. You can make a standard 401k withdrawal if you are no longer an employee for the employer that sponsors your 401k plan and are at least 59.5 years old.
If you have invested money into a standard 401k, you will be required to pay income tax whenever you eventually withdraw your money. However, there will be no penalty applied to the withdrawal since you’re over the age of 59.5. After you reach the age of 72, you will need to take out the required minimum distributions from your 401k every year. The amount that you withdraw is based on an IRS formula that dictates the amount by the age you are at the time of the withdrawal. While you can always withdraw all of the money from your 401k account in one withdrawal, this can lead to a significant tax bill that you might want to avoid. If you’re still working in the same workplace, there are some plans that allow you to delay the required minimum distributions until the year that you retire.
You should also know about hardship withdrawals when using a 401k account. A hardship withdrawal means that you can only withdraw money from your account without penalties for various emergency purposes in the event that you’re older than 59.5. The many different emergencies that would allow you to qualify for these penalty-free withdrawals include:
- Up to 12 months of educational fees and tuition
- Medical expenses for care and treatment that are deemed to be essential
- Expenses related to a funeral or burial
- Expenses that will allow you to prevent being evicted or foreclosed on
- Home-buying expenses for a main residence
Being able to withdraw money from your 401k account without incurring a penalty in the event of one of these emergencies occurring should give you peace of mind about investing in a 401k.
Types of 401k Accounts
There are various types of 401k accounts that you should be aware of, which include both a Roth 401k plan and a solo 401k plan. The Roth 401k plan is considered to be highly advantageous for individuals who expect to be wealthier once they reach retirement age. Since the money that’s placed into the account can be withdrawn without requiring you to pay taxes, all of the money in your account once you reach 59.5 is yours to be withdrawn whenever you’d like.
The Roth 401k is among the latest types of retirement plans. While this is a special 401k plan, it provides investors with many of the benefits that can be received from a Roth IRA. The money that you contribute to the plan can’t be written off of your taxes, which means that you should weigh the pros and cons of a Roth 401k alongside a traditional 401k. If the tax benefits that you can receive now are more appealing to you, a traditional 401k might be your preferred option. On the other hand, a Roth 401k allows you to avoid the hassle of paying taxes when you eventually withdraw from the account. The type of 401k account that you select depends largely on your personal preference.
Using Your Solo 401k Plan to Invest in Real Estate
If you want to use your 401k account to invest in real estate, you will need to use a solo 401k plan. A solo 401k requires owners of the account to make contributions with their pre-tax dollars. These contributions can continue to grow within the account tax-free until you withdraw them for retirement. Keep in mind that there are limits to how much you can place into a solo 401k plan in a single year. For 2020, the limit is set to $57,000. If you’re currently older than 50 but have yet to retire, you can add an extra $6,500 per year above the $57,000 limit.
In order to qualify for this type of plan, you will need to be self-employed without having any employees that require W2 forms. However, it’s possible for your spouse to work with you. When you have a solo 401k, your investing possibilities will be broadened significantly since this type of account allows investments to be made in any asset that’s not disallowed under IRS regulations. The types of assets that you can invest in with a solo 401k plan include:
- Tax liens
- Private loans
- Private businesses
- Limited liability companies
This gives you investment leeway that’s not possible with other 401k accounts. After you save for retirement for a certain number of years, you might want to think about investing in something with high returns and relatively predictable cash flow, such as real estate. By making these investments before you reach retirement age, you should be able to increase the amount of money that you have when you eventually retire. The types of real estate investments that you can make include:
- Developed land
- Residential property
- Commercial property
Each of these real estate investment opportunities can provide you with stable returns as long as you make smart investments. There are many benefits that come with investing money in real estate. These benefits are compounded when you invest in commercial real estate properties. The main reason that you should think about investing in real estate is that these properties generally appreciate in value over time, which allows them to increase in value with inflation. The average appreciation amount per year since 1968 is right around six percent.
If you invest your money into an apartment building, you can collect money from tenants, which will provide you with monthly payments. You could also make a debt investment in these properties, which would give you the opportunity to collect monthly payments from the interest on the loan that you’ve provided. Whether you like to make risky investments or safe ones, real estate investing accommodates both types of portfolios. Real estate gives you a predictable cash flow and offers equity growth via debt reduction. If you invest into the equity of a property and are in charge of upkeep for the building that you own, the money that you spend on maintenance, improvements, and property upkeep are considered to be tax-deductible, which you can use to reduce the amount of taxes that you owe each year.
Ready to Use Your 401k to Invest in Commercial Real Estate?
If you would like to use your solo 401k to invest in commercial real estate, it’s important that you focus on making the right investment decisions. The real estate that you invest in should be heavily researched so that you can be confident that the property and real estate market surrounding it are in good condition. While it’s not possible to eliminate all risk that comes with making an investment, the research that you do now should help you mitigate risk, which can assist you in maintaining a balanced portfolio.
*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.