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Help your Clients Help Themselves: Finding Real Estate Investment Money in Your 401(k) Plan

Sep 3, 2014

Posted by

Ken Holman

Kenneth T. Holman is president of Overland Group, RE/MAX Overland, and the National Association of Real Estate Investment Advisors. For more than 30 years, Mr. Holman has had extensive experience in t Read more

Real estate brokers and agents who attend our certification classes for Real Estate Investment Advisors are often looking for ways to help their clients make real estate investment part of their retirement planning process.  That’s good for the client—and good for the agent.  Because even though most people will only be in the market for a new home every eight to ten years, they can become “full time” clients if they get into the real estate investment marketplace.  And many of them have available funds that they are not even aware of—hidden in their 401(k) plans.  Here is some background on that for you to pass along to your clients.

A survey conducted some time ago by Schwab Retirement Plan Services revealed that 57 percent of respondents struggled with choosing the right investments for their 401(k) account and 68 percent lacked confidence in their own ability to make the right 401(k) investment choices.

Does this sound familiar?

Oftentimes, plan owners lack the knowledge and expertise to make wise investment choices. They rely on the expertise of those administering the plan, but usually the performance results of their 401(k) investment choices are underwhelming, to say the least. It seems the company and the plan providers make more money on administering the plan than the actual owners make on the investment choices offered by the plan administrator.

Dalbar, Inc., a reputable financial research firm, did a 20-year study and found that the average mutual fund investor earned an average annual return of 3.27 percent. That barely keeps up with inflation, let alone grows personal portfolio wealth for retirement! To make matters worse, about 60 percent of all 401(k) plan assets are held in mutual funds. Read further to see how to get out of this Catch 22 situation.

Does this scenario match your experience?

When you were hired, the company offered you a 401(k) Plan with T. Rowe Price or Fidelity or some other large stock brokerage firm your company was affiliated with. You were given a copy of the Summary 401(k) Plan Description. A representative of your company or the stock brokerage firm then sat down with you and explained the company contribution matching policy and discussed with you things like your risk tolerance, your goals for your retirement account, etc.

After some deliberation, the representative explained the importance of diversification and asset allocation and suggested a number of mutual fund options you could select from, and if you didn’t like their suggestions, you could pick from any number of the other 14,000 mutual funds that are traded publicly, as long as their company offered them. You were never given an option to select an investment product that was not part of your plan provider’s choices.

 

From there, you began contributing to your company 401(k) plan and the company provided the appropriate match, usually a 100 percent match up to 3 percent of your income and a 50 percent match on the next 2 percent of your income, for a total match of 4 percent of your income.

This approach reminds me of how Boss Hogg handled Sheriff Rosco P. Coltrane in Dukes of Hazzard. When Coltrane asked what his cut would be on some nefarious deal, Boss Hogg would say something like, “Why, your cut will be 3 percent of 2 percent of 4 percent.” Coltrane was always giddy with excitement because the cut sounded big, but it really was infinitesimally small if you ran the calculation.

How does the company matching contribution work?

Say you are making $100,000 and elect to contribute to your 401(k) plan. For every dollar you put into your retirement account up to $3,000, the company will match it 100 percent. Then, if you contribute another $2,000, the company will match up to 50 percent, for a total company matching contribution of $4,000. In essence, you contribute $5,000 to your 401(k) plan and the company will contribute an additional $4,000. That’s a pretty good deal.

Are other options available?

Now, suppose you have been with the company a number of years. You’ve contributed a lot of money to your 401(k) plan. The company has contributed the appropriate matching funds. What’s the next step if your 401(k) plan has been underperforming? Can you simply go to your plan provider and say you want out? Will they let you invest in alternative investments that may give you a higher overall return? The answer is no. Even though it’s your money, you are limited in your investment choices.

If you go to your plan provider and tell them you want to transfer your money to another retirement program that offers a better return or to invest in alternative investments like real estate, they will tell you that you can’t transfer your funds from the plan until you retire or your employment is terminated. Well, if you read the plan documents, that statement is not entirely true. Your company’s plan description does outline a number of options available to you to take money from your 401(k) and invest in alternative investments like income-producing real estate. You just have to make the right moves.

Investing solely in mutual funds and bonds with your retirement funds is not a smart way to build your retirement wealth. You need to be buying alternative investments like income-producing real estate. At retirement, mutual funds get sold to provide sufficient income to live on while real estate assets get held because you live off the income they produce.

Controlling your Retirement Funds

Here’s a few ideas I have discovered that will give you control of the cash you need. These ideas allow you to take advantage of the company match while freeing up capital to buy alternative investments, like income-producing real estate, which usually offer higher predictable returns and create a more profitable path to retirement wealth accumulation.  

First,

check your company’s plan description to see if it permits an in-service withdrawal. Most plans permit withdrawing funds from your vested retirement account when you reach the age of 59 ½. At that age, you can keep your existing company 401(k) plan going but can withdraw money from the account and roll it into another self-directed retirement account, like an IRA or Individual 401(k). If you are going to invest in income-producing real estate, I recommend rolling your money into a self-directed individual or solo 401(k) rather than an IRA.

Second, see if your current 401(k) plan permits you to withdraw any deductible employee contributions (DEC) while you are still working for your employer. A DEC contribution is any qualified voluntary contribution, i.e., any amount contributed on behalf of any individual to a plan described in Internal Revenue Code §501(c)(18), that is made after Dec. 31, 1981 and allowable as a deductible contribution in the taxable year. That means the employee portion of the contribution may be permitted to be withdrawn and transferred to another qualified self-directed retirement account.

Third, review your plan to see if it permits plan participants to borrow money from the 401(k) plan. Usually, the amount you are permitted to borrow is up to $50,000 or 50 percent of the vested account balance, whichever is less. So, if you have $100,000 in your retirement account, you can borrow $50,000 and invest it in income-producing real estate. You are required to pay the loan back, usually at a rate of prime plus 1 percent. Assuming the Wall Street Journal Prime Rate is 3.25 percent, your loan repayment rate would be 4.25 percent. If you can earn 8 percent cash-on-cash return on your income-producing real estate investment, you pick up the spread of 3.75 percent. The interest you pay on your 401(k) loan is money you pay back to your own retirement account over five years.

Fourth, only contribute enough to your company 401(k) plan to get the company matching contribution. In our example, you contributed $5,000 in your account and received $4,000 in matching contributions. That means you could invest an additional $12,500 in another qualified plan that permits alternative investments, since the employee contribution limit permitted by the IRS in 2014 is $17,500 if you are under 50. If you are 50 or older, the limit is $23,000, so you could invest an additional $18,000.

Fifth, set up an alternative self-directed individual or solo 401(k) plan that permits you to control the retirement funds and invest them in alternative investments, like income-producing real estate. You must meet the eligibility requirements for these plans, but that is not too difficult. They can even be used in conjunction with an S-corporation or limited liability company (LLC) where you have full control and check-signing ability.

Finally, rollover all the available retirement funds from your existing company 401(k) plan and begin investing in alternative income-producing real estate and other types of investments that yield higher returns. In the future, contribute enough capital to your company 401(k) plan to get the matching contributions, but channel the rest of your retirement contributions to a qualified self-directed individual or solo 401(k) plan.

Go ask the company representative if you can invest directly in real estate, and when they tell you that you cannot withdraw funds from your 401(k) account until you retire or terminate your employment, be polite but don’t believe them. There are several ways you can withdraw funds from your retirement account, roll the money over into a new qualified self-directed retirement account and begin investing in income-producing real estate.

Need Some Help?

If you need help investing in income-producing real estate or setting up a self-directed individual or solo 401(k) account, contact Ken Holman. He can help you. He’s been investing in real estate for more than 30 years. Mr. Holman is the president and owner of the National Association of Real Estate Investment Advisors and Overland Group, Inc. Contact him at kholman@overlandcorp.com. Or sign up for one of his classes at www.NAREIAGroup.org.