Once you decide to save, you still have to determine where you want to invest your hard-earned dollars. Many people default to stocks and bonds. Instead, consider building your nest egg by investing in real estate.
Start With Your Retirement Plan
If you work for a company, your employer probably offers you a retirement plan, such as a 401(k) or 403(b). These plans enable you to invest with pre-tax dollars, so you don’t pay taxes until you take the money out during retirement. Some companies match your own investment up to a certain percentage. So, if you contribute 5 percent, they add 5 percent, too. That’s getting free money.
You can also save pre-tax dollars in a traditional IRA and post-tax dollars in a ROTH IRA after you reach the contribution limits of your company plan. Most retirement plans limit contributions based on your age and income. So make sure you research the guidelines before making investments.
While many financial institutions restrict the types of investments you can use in their IRAs, some offer Self-Directed IRAs (SDIRAs). SDIRAs enable you to invest in alternative investments, including direct investment in real estate projects. But keep in mind that you can’t transfer ownership of real estate you already own to a Self-Directed IRA. SDIRAs require arm’s length transactions, so you can’t purchase personal property, like a primary residence, second home or vacation home. You also can’t do real estate deals with immediate family members.
Invest in Real Estate
Most employer-sponsored retirement plans and traditional IRAs allow you to make your investment choices only inside the plan. Many investors opt for stocks, bonds or mutual funds, but you can also invest in real estate using Real Estate Investment Trusts (REITs).
A REIT or Real Estate Investment Trust is similar to a mutual fund, but you invest money in real estate projects instead of stocks and bonds. The REIT uses the invested funds to buy and operate commercial and residential real estate that generates income. It can also finance real estate deals. The REIT manages properties and collects rents from the building’s tenants. Then it pays a portion of the lease payments to Investors in the form of dividends. In fact, REITs have to pay out at least 90 percent of taxable income to shareholders as dividends.
A board of directors manages each REIT, which must have at least 100 shareholders. (No fewer than five shareholders can own 50 percent of the shares). The REIT also has to invest at least 75 percent of its assets in real estate, cash or U.S. Treasurys, and generate 75 percent of its income from real estate. Finally, 95 percent of income has to come from passive sources like rents.
Use Self-Employed and Self-Directed Retirement Plans
If you’re self-employed or own your own business, you can use an SDIRA, Solo 401(k), SEP or SIMPLE IRA to sock away money for the future. Each of these retirement plans can hold physical real estate.
Similar to employer-sponsored plans, you can invest with pre-tax dollars. You use the money invested in the plans to buy and operate the real estate projects. Plus, if you reinvest the income produced from the properties, you don’t pay taxes until the plan distributes your savings during your retirement years. Again, regulations restrict the real estate deals to arm’s length transactions.
Supplementing Your Retirement Plans
In addition to retirement plans, you can build your retirement nest egg by direct investment in real estate. Some real estate investors like to flip properties, but this can be expensive, time-consuming and bank-account-draining if you get stuck with a house that doesn’t sell quickly.
A better strategy is to buy properties that generate cash flow. Cash flow means money is left over each month after you collect and pay the mortgage, upkeep and other expenses for the property.
After you retire, you can continue to take the income from rents, or sell it if the property has increased in value. Except in rare cases, real estate value generally increases the longer you hold onto it.
You can avoid the hassles of managing your own real estate by investing in crowdfunded real estate projects or real estate platforms like HappyNest. In fact, HappyNest lets you start investing in real estate with as little as $10.
Get Started Now
Now that you know how to build your nest egg, it’s time to get started. No matter which kind of real estate investment you choose, first max out your pre-tax and post-tax retirement plans. Then you can put your additional dollars in the real estate investments that suit you the best.
Chris Brantley, the author, is a freelance writer, who has written about finance and investments since 1998. He has contributed to various financial and investment publications and web sites, including The Motley Fool.