Real Estate Investing: Safe Investment with High Returns for Your Retirement

We all know we need to plan for our retirement despite how we like to put it off, our old age is coming. One of the best ways to ensure our financial security is by investing in an IRA that generates enough income to maintain our accustomed standard of living. Traditionally this is done with stocks and bonds but you can also invest in real estate and when done correctly real estate is safer than the stock market and can create some excellent returns.

What is an IRA?

First of all, an IRA is an Individual Retirement Account and it is an investing tool that works in a tax advantaged way so that individuals can earmark savings for retirement. IRAs are offered at many different types of financial institutions including banks, credit unions, brokerages and savings and loans associations. Essentially any institution that has approval from the IRS to do so may offer IRAs to their customers.

Think of an IRA like a bucket. By itself it is not much good. But you can put things in a bucket and carry it around with you and it becomes very useful. Simply having an IRA is not very useful (like an empty bucket). However, like a bucket, you can fill your IRA with investments and hang on to them for as long as you like.

There are several different types of buckets (IRAs):

• Traditional IRAs
• Roth IRAs
• SEP IRAs
• SIMPLE IRAs

You contribute money into your IRA and then use that money to purchase investments. Traditional and Roth IRAs are for individuals and SEP and SIMPLE IRAs are for small business owners and self-employed persons. You can only contribute to IRAs with earned income as defined by the IRS and because these accounts are meant to be only cashed out upon retirement there are penalties for early withdrawals. The IRS imposes limits on how much you can contribute to your IRA in any one year.

Traditional IRA's

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Typically, when you contribute to a Traditional IRA your contribution is tax deductible thereby reducing the amount of taxable income in the year you made your contribution. This can be a great way to save on the overall amount of tax you have to pay. When you withdraw from your IRA in retirement however, you will have to declare that as income and pay tax on it at that time. Ideally, in your retirement you will be in a lower tax bracket and end up having to pay less tax on your earnings from investments overall.

There are contribution limits that are dependent upon your yearly income as well as minimum withdrawals once you reach the age of 72. The investment products available in a traditional IRA include stocks, bonds, ETFs and mutual funds.

Roth IRA's

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The best thing about Roth IRAs is that your investment gains, and withdrawals during retirement, are tax free. Unfortunately, your contributions are made with after tax dollars so you do not get to count them as a deduction. There are no minimum withdrawals required and there are contribution limits just like the traditional IRA but there also income limitations on having a Roth IRA. If you are single and earn more than $122,000 per year you cannot contribute to a Roth IRA (the figure is higher if you are married).

SEP IRA's

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This stands for Simplified Employee Pension. Intended for self-employed tax payers like freelancers, independent contractors and small business owners they follow similar taxation rules for withdrawals as traditional IRAs. A major difference comes in the contribution limits allowed.

For 2019 businesses can contribute up to 25% of compensation (max of $56,000) to an employee’s SEP IRA and the business can deduct this contribution. Employees may NOT contribute to a SEP IRA at all. Withdrawals count towards the employee’s income.

SIMPLE IRA's

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This stands for Savings Incentive Match Plan for Employees. This is very similar to a SEP IRA and also follows the taxation rules of the traditional IRA, but unlike the SEP the employee is allowed to make contributions. The employer is required to make contributions as well and all contributions are tax deductible (potentially lowering the tax bracket of both the business and the employee).

For 2020 the contribution limit for employees is $13,500 and any contributions must be matched by the employer.

Real Estate within your IRA

All of the above-mentioned types of IRAs are offered by a wide variety of financial institutions and they handle the investments held within those accounts. A self-directed IRA (SDIRA) is a special type of IRA that is also offered by a few financial institutions but the types of investments that can be held within it is much broader. In fact, you can purchase tax liens, private placements and even real estate.

Why use a SDIRA to purchase Real Estate:

Real Estate is a great investment that will diversify your current portfolio of stocks, bonds and mutual funds. The Real Estate market often moves counter to financial markets and this provides protection when excessive unwanted volatility hits the S&P500.

Historically Real Estate has appreciated over time, doubling every 5-10 years depending on market conditions. This is perfect for the longer time horizons that are enforced by investing within your IRA.

Rental income from your real estate holdings can provide a steady stream of income and all of this income flows into your IRA to grow tax differed (or tax free in the case of a Roth IRA). In this way you are protected from inflation as well since you can always increase the rent.

It is possible to buy and sell, flip or accumulate real estate within your IRA. This way as your retirement nest egg grows so to can you real estate holdings.

Real estate is a tangible product unlike corporate shares. Its value will never drop to zero so you have an automatic safety net when you invest in real estate. This doesn’t mean that property valuations can’t drop. They can. But real estate will always have at least some value and the longer you hold it the more time it has to appreciate.

Conclusion: Investing in real estate within your self-directed IRA is a great way to safely invest your earnings. You can enjoy the security and safety of owning tangible real assets and yet still achieve an excellent return to grow your retirement accounts. Since the real estate market runs on a different cycle to stocks and bonds it can provide some much needed diversity in your investments. Allowing your investment returns to grow in a tax advantaged way within your IRA and the longer timelines that are encouraged by IRA rules make for a good fit. The rental income that you earn from your real estate investments will provide for steady and stable growth and will protect you from inflation as well. Best of all, is that real estate never goes away. It will not ever fall to zero so as your retirement account grows you can accumulate more and more of it further broadening your financial base and security.