IRA and 401K Basics
In 1974 Congress enacted the Employee Retirement Income Security Act which allowed taxpayers the opportunity to invest a portion of their earnings for retirement and reduce their taxable income by the amount of their contributions. This opened the door to what we today call Individual Retirement Accounts or IRAs.
In January 1980 the Revenue Act of 1978 gave employees a tax-free way to defer compensation from bonuses and stock options under section 401(k). In 1981, the IRS issued additional rules that allowed employees to contribute to their 401(k) plans through salary deductions, which jump-started the widespread roll-out of 401K plans as we now know them.
Since that time, investors have been leveraging both IRAs and 401K plans to save for retirement while simultaneously easing their tax annual tax burden (up to allowable amounts).
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IRA and 401K for Real Estate Investing
However, traditional IRAs and 401K plans have been limited to investing in stocks, bonds, mutual funds, ETFs, etc. Some investors have searched for opportunities to diversify their investments beyond the market, giving rise to Self-Directed IRAs (SDIRAs). SDIRAs open up a large universe of potential investments, including real estate investing.
401K plans, as employee-sponsored programs, are limited in scope and don’t allow investing in real estate. However, employees can convert (or roll over) their 401K investments from a former employer into an IRA which can be structured as a Self-Directed IRA with the assistance of special firms that offer SDIRA custody services.
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SDIRA Limitations
Of course, there are limitations on SDIRAs as well. For example, you can’t hold life insurance, S Corporation stocks, any investment that constitutes a prohibited transaction (such as one that involves “self-dealing”) or collectibles.