I learned about investing when my father introduced me to his brokerage account at a young age. It was through him that I learned what stocks were and grasped a general idea of how the stock market works. He set up a custodial account for me (as I was under the age of 18) and put my life savings in stocks, a whopping $1,000 that I had saved from birthdays and mowing lawns. Investing for your children is relatively easy as all you need to do is set up a brokerage or custodial account if they are under the age of 18. Not all parents may be knowledgeable about the stock market, however. Alternatives such as real estate, offer a wider variety of investments that appeal to a broader market.
REAL ESTATE INVESTING WITH CHILDREN
Like stocks, properties tend to go up in value over time. You can also rent a property and generate a passive stream of income.
Real estate investing is not for everyone, but for those in the real estate industry, this may be a preferred alternative (or addition) to investing in the stock market. Purchasing real estate with your children is simple and self-explanatory; find a property, buy the property. You could even own the property 50/50 with your child. If you are using IRA funds, financing can be challenging as there will be additional rules and potential taxes in which you will need to familiarize yourself. For this reason, most IRA transactions are cash.
INVESTING WITH RETIREMENT ACCOUNTS
Saving should be taught at a young age, especially the importance of investing with IRA accounts where gains grow tax-deferred. Unfortunately, my father was not very knowledgeable about IRA accounts, and it was not until I started working at Midland that I began to understand the importance of saving for retirement using tax-deferred strategies such as IRAs, HSAs, ESAs, 401ks, and 1031 exchanges. IRAs and other investment options are not taught in school, so it’s important to teach your children at home.
To be eligible to contribute to an IRA, you must have earned income from a salary, commissions, tips, or bonuses. It is unlikely that your child is working a summer job solely to save for retirement! However, if you have expendable cash, you can always gift your children money. The annual gifting limit is $15,000 per year (as of 2020). As long as your children have enough earned income from a job, they can potentially use the proceeds of your cash gift to help them max out their IRA contributions and even HSA and 401k (if eligible). Learn more about gifting money to your children for retirement savings.
Investing in stocks through an IRA is very straight forward. All you have to do is set up an IRA brokerage account and buy a stock. Investing in real estate through IRA funds is a little more complicated. A brokerage is not going to allow you to make this investment, as it is not in their business model. They will try and pitch you the option of purchasing Real Estate Investment Trust (REIT) stocks instead. However, you can use your retirement funds to invest in real estate, which includes buying land, rental properties, commercial properties, and even loaning money via promissory notes. All of this can be done in a tax-deferred manner using self-directed retirement accounts such as 401ks, IRAs, ESAs, and HSAs. While your children likely do not have the same amount of income or retirement funds as you do, this does not prohibit them from investing in real estate using retirement accounts. It just means things may have to be structured a bit differently.
QUICK RULES OF INVESTING IN REAL ESTATE USING IRAS
- The first step is to find a self-directed IRA custodian, such as Midland, that can do the recordkeeping and report to the IRS on the movement of funds and the real estate in the IRA.
- You do not need to own the property 100% with IRA funds. When purchasing the property, you can team up with other entities or your funds. However, going forward, all expenses and income have to remain proportional to how the property was purchased. For example, if you buy a $100,000 property using $90,000 (90%) of your IRA funds and $10,000 (10%) of your child’s IRA funds, going forward, all expenses and income have to remain in this proportion. If your real estate tax bill is $1,000, then your IRA would need to pay $900 (90%) and your child’s IRA would need to pay $100 (10%).
- You cannot live in the property personally or have disqualified people living in the property if your IRA owns it. Disqualified parties include your parents, grandparents, spouse, children, grandchildren, daughter, and son’s/daughter’s in-laws.
- You cannot put “sweat equity” into the property, which means you and disqualified parties cannot add value to the property by cleaning, fixing, replacing, or landscaping.
- When investing in real estate using your IRA, it is highly recommended to maintain an IRA cash balance to cover unexpected costs associated with owning property.
If you have questions or want additional information on investing in real estate with your children, call us at 239.333.1032 or visit www.midlandtrust.com.
MIDLAND TRUST IS NOT A FIDUCIARY: Midland’s role as the custodian of self-directed retirement accounts is non-discretionary and administrative in nature. The account holder or his/her authorized representative must direct all investment transactions and choose the investment(s) for the account. Midland has no responsibility or involvement in selecting or evaluating any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.
AUTHOR: Andy Anger, Senior Associate in Client Services at Midland Trust