Traditional retirement account investments for investors include stocks, bonds, and mutual funds. However, there are alternative options for retirees looking to diversify their portfolios, such as passive real estate investments. As a result, this essay aims to provide advice on making passive real estate investments with retirement funds.
This essay will concentrate on the following aspects of passive real estate investing using retirement account funds:
- SDIRAs vs. Passive IRAs
- Passive 401k vs. IRA Real Estate Investment Options
- Option 1: REITs
- Option 2: ETFs on Real Estate
- Option 3: Mutual Funds on Real Estate
- Option 4: Industry Stocks on Real Estate
- Concluding Thoughts
SDIRAs vs. Passive IRAs
Let’s start with what this essay doesn’t cover: SDIRAs, or self-directed individual retirement accounts. Individuals can hold various alternative asset classes in these retirement accounts, including real estate. And as the name implies, the individual account holder maintains the account’s investments directly, while a separate custodian handles the administration.
SDIRAs are excellent ways to invest in real estate in a retirement plan. However, they necessitate significantly greater A) cost, B) administrative load, and C) active participation than traditional retirement funds. As a result, because we do not consider this investing entirely passive, we will not discuss it in this post. Instead, we’ll discuss using SDIRAs to invest in real estate in a separate essay dedicated to these accounts.
In this article, we will discuss the passive choices available to investors for investing in real estate through regular retirement accounts, such as traditional and Roth IRAs and 401(k) plans.
Passive 401k vs. IRA Real Estate Investment Options
401(k)s and IRAs are two popular tax-advantaged retirement accounts that provide substantial advantages to savers. And there are numerous similarities between the stories. Both pension and profit-sharing schemes offer the choice between the standard and the Roth pension. Investors get an immediate tax break with a typical 401(k) or IRA. That is, the account holder pays taxes when they take money in retirement, but their payments are tax deductible now. However, the Roth variations of both plans provide favorable tax treatment in the long run. Although contributions do not lower taxable income in the present, withdrawals made in retirement are tax-free.
The difference between the two is mostly based on who pays for what. Individuals set up IRAs, whereas employers sponsor 401(k)s. The yearly contribution limitations for 401(k) plans are larger than those for IRAs, and many 401(k)s are eligible for an employer matching contribution.
Either account can be used to buy the following investment alternatives: passive real estate investments. 401(k) plans, on the other hand, are sponsored by employers and hence often have fewer investment possibilities than individual retirement accounts (IRAs). And employees can’t exert any influence over the 401(k) plan’s management, so they can’t increase their investment choices. Therefore, if a 401(k) plan does not permit the acquisition of a specific real estate investment, plan participants are not permitted to do so. Investors can either A) start contributing to an existing IRA or B) open a new IRA and roll over their 401(k) funds into it.
REMINDER: Rolling over a standard retirement plan into a Roth IRA may have tax implications for investors. Talk to your tax preparer or certified public accountant before making any sweeping financial changes.
In the succeeding four paragraphs, we will discuss four strategies for investing passively in real estate using retirement savings. While each has its own set of nuances, they can all be used to diversify retirement portfolios into real estate with minimal active management.
Option 1: REITs
The real estate investment trust, or REIT, allows people to put their money into commercial real estate without buying and managing individual buildings. In the 1960s, Congress established this choice to attract more people interested in real estate investment.
In general, REITs are commercial property owners and managers. Mortgages on these properties are another investment option for some REITs. Either way, REITs must distribute at least 90% of their taxable income to shareholders’ yearly dividends to conform with IRS regulations. Many investors are attracted to REITs because they are required to pay a higher dividend than equities or mutual funds.
Investing in publicly traded real estate investment trusts (REITs) is a simple way for people to gain exposure to the real estate market while remaining hands-off. Finally, there is a significant benefit to investing in REITs with money from a retirement account. Dividends from real estate investment trusts (REITs) are not taxed preferentially like dividends from stocks. Instead, the Internal Revenue Service taxes dividends at the investor’s ordinary income rate. Therefore, investors can save much money on taxes by keeping these investments in a tax-deferred retirement plan.
Option 2: ETFs on Real Estate
In most cases, a single type of real estate is the primary emphasis of a given REIT. While some real estate investment trusts specializing in industrial properties, others include portfolios of multifamily buildings. Concentration risk tends to rise with such a regional focus.
Real estate exchange-traded funds, or ETFs, provide investors with greater diversification than a single REIT. In addition to using retirement savings to buy exchange-traded funds (ETFs), another perk is that these funds are publicly traded and pay dividends. Exchange-Traded Funds (ETFs) are a specific kind of mutual fund that tracks a group of underlying assets, often individual REITs. Consequently, real estate ETFs offer far more diversity across asset classes than a single REIT.
Most real estate investment trusts (REITs) specialize in a certain type of property, but real estate exchange-traded funds (ETFs) follow the performance of a basket of underlying REITs. Moreover, they achieve this goal by passively following a REIT index. This means that investors can acquire exposure to the property types of all REITs in the underlying index with a single ETF purchase. This is a terrific method for those who want a hands-off investment approach. Investors can attain real estate sector diversity with a single ETF, saving them time and effort throughout studying and developing a diversified portfolio.
Option 3: Mutual Funds on Real Estate
As with ETFs, real estate mutual funds function as a collective investment vehicle. When people invest in a mutual fund, they purchase shares in a pool of assets. Buying shares in a real estate mutual fund provides retirees instant diversification and dividend income.
Many real estate mutual funds are actively managed, unlike exchange-traded funds, which often mirror an underlying index. Consequently, an individual is responsible for making all of the mutual fund’s investing decisions. A real estate mutual fund could be the better option for those who would rather have more control over their investments than an index-tracking ETF.
Unfortunately, this choice is not uncommon to incur another expense. Because of their more hands-on approach to managing investor money, many real estate mutual funds charge higher fees than equivalent exchange-traded funds (ETFs). The initial investment is also usually bigger. This means that A) when making judgments about their retirement accounts, investors will need to consider the costs associated with various mutual funds and B) how well each fund has performed on its own. Is it reasonable to assume that a given real estate mutual fund’s past returns will lead to a positive outcome in the future? Each investor must make this choice individually, considering their unique investing aims.
Option 4: Industry Stocks on Real Estate
People’s retirement savings can be invested passively in real estate similarly. Investors’ funds can be used in the real estate market through exchange-traded funds, investment trusts, and real estate mutual funds (or the associated mortgages). Of course, buildings are only one part of the larger real estate market.
Suppose you’re an investor trying to diversify your portfolio away from the volatile real estate market. In that case, you can use your retirement savings to buy stocks in firms that provide services related to the real estate market. The real estate industry encompasses a wide variety of subsectors, including but not limited to those involved in construction, development, building supplies (such as steel, lumber, etc.), mortgage finance, sales and marketing, and property management. Additionally, retirement savings can buy stock in companies operating in these sectors.
Investing in a single company’s stock exposes a person to more risk than buying shares in multiple companies. However, the inverse is also true. The returns on investing in the stock of particular companies might be very high. Therefore, investors need to weigh the benefits of higher return potential against the risks associated with investing in a single company.
Concluding Thoughts
Outstanding profits and portfolio diversification can be had through passively investing in real estate for retirement. Passive investments can be made in real estate investment trusts, exchange-traded funds, mutual funds, and equities in linked industries.
We understand, however, that even with the factors mentioned earlier outlined, it may still seem difficult to choose the finest investments.
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