By Dane Bowler, Guest Writer
Are you unsure about how to make the most of your 401(k) contributions? If so, you're not alone. Many individuals struggle to navigate the world of retirement savings and often find the available investment options underwhelming. That's where REITs come in.
What Are REITs?
A REIT (Real Estate Investment Trust) is a special tax designation for companies that have the majority of their assets and revenue derived from real estate. To maintain REIT status, these companies must pay out at least 90% of their taxable income as dividends to shareholders. The benefit? They are exempt from corporate tax.
Using REITs to Supplement a 401(k)
Tax Advantages of a REIT
Unlike most stocks, which are subject to double taxation, REITs avoid corporate tax. Instead, they pass their taxable earnings to shareholders in the form of dividends. Shareholders are then taxed on these dividends and capital gains. This single layer of taxation offers a significant advantage over traditional stocks and ETFs.
What Counts as Real Estate in the Eyes of the IRS?
While houses and commercial real estate are obvious examples of what the IRS considers as real estate, there are other surprising assets that qualify. Even the land or rooftops underneath solar panels count, as long as they are not actively involved in energy production. REITs can own these assets and lease them to operators, enhancing the tax efficiency of the supply chain.
4 Main Types of REITs
When investing in REITs, it's essential to understand the different types available:
- Equity REITs: These directly own income-producing real estate.
- Mortgage REITs: These earn interest income by financing real estate.
- Non-traded Public REITs: They are not listed on a public stock exchange but are still considered public. These can be equity or mortgage-based.
- Private REITs: These require accredited investor status and generally have fee structures similar to hedge funds.
Publicly traded equity REITs tend to be the better option, as mortgage REITs can struggle in certain interest rate environments, and non-traded REITs often come with high fees.
Why Invest in REITs Alongside a 401(k)?
While your 401(k) may consist primarily of traditional stocks or ETFs, adding a separate portfolio of REITs can provide diversification and reduce overall volatility. REITs offer transparency, higher dividend yields, and a low correlation with other asset classes.
During the "lost decade" from 2000 to 2009 when the S&P 500 had a total return of 0%, REITs delivered an impressive 182.7% return. By incorporating REITs into your portfolio, you can achieve diversification without sacrificing returns.
Final Thoughts
Investing in REITs alongside your 401(k) can be a smart move to enhance diversification and potentially increase your returns. Make sure to consider the different types of REITs and consult with a financial advisor to determine the optimal allocation for your portfolio.
[Founder's Note from Dr. Jim Dahle: Like the author, I am also a fan of diversifying into real estate...]
What are your thoughts on using REITs to supplement your 401(k)? Share your opinions below!
[Editor's Note: Dane Bowler is an investment advisor representative of 2nd Market Capital Advisory Corporation...]
