By Rob Johnson
There are dozens of compelling reasons to save for your retirement years, including retiring with enough money to live comfortably, retiring early, buying a vacation or second home, paying for unpredictable medical costs, and building generational wealth.
Millions of Americans are saving for their retirement years by participating in employer-sponsored retirement plans. According to the American Benefits Council, more than 105 million Americans use employer-sponsored 401(k)s to build tax-deferred wealth to see them through their retirement years. The National Association of Plan Advisors, meanwhile, reports that there is more than $30 trillion in assets held in 401(k)s and similar types of retirement accounts.
401(k)s and other retirement plans are the go-to options to build retirement savings for a variety of reasons:
● Taxes on contributions are deferred.
● Contributions can reduce annual taxable income, decrease tax liabilities, and even place you in a lower tax bracket.
● Tax-deferred investment capital can potentially grow over time through the power of compound interest.
Although 401(k)s are the de facto choice for hard-working Americans to pursue a sound financial future for their retirement years, the income they provide still might not be enough for many to maintain their current lifestyles in retirement.
The Retirement Income Gap — and How to Bridge It
Even though you’ve saved for retirement throughout your whole career, you still might not have enough money once you stop receiving regular paychecks. The ever-increasing cost of living, coupled with unforeseen expenses such as exorbitant medical bills or specialized senior care, could rapidly undo decades of savings and financial sacrifice.
The gulf between the funds you’ve saved for retirement, combined with recurring income such as Social Security, and the amount of money you’ll actually need is commonly called the retirement income gap. You can do some simple back-of-the-napkin math to estimate if you have enough income to meet your retirement needs. Add up the value of your current assets, such as your 401(k), cash, stocks and bonds, as well as guaranteed income from Social Security, pensions or annuities, and compare that number against your estimated annual retirement expenses.
A negative number means you’re likely to experience a shortfall of funds in retirement, and you may have to adjust to a step-down in lifestyle. Even if you’ve calculated a surplus of income, you still could be derailed by bear market downturns and escalating healthcare costs.
Bridging the retirement income gap may require you to reposition existing capital deployment to generate additional wealth. Countless investors have successfully used real estate to build their personal wealth. Two financial products that are available to all types of investors that can be leveraged to potentially generate tax-advantaged income include 1031 exchanges and Delaware Statutory Trusts (DSTs).
What Are 1031 Exchanges and DSTs, and How Can They Build Tax-Deferred Wealth?
Investors who divest income properties often complete 1031 exchanges in order to defer capital gains taxes on proceeds generated from the sale. In a 1031 exchange, a real estate investor relinquishes his or her original investment property and rolls the proceeds into a like-kind replacement asset. Investors use this investment vehicle to defer capital gains taxes, as well as to create increased portfolio diversification by purchasing real assets that are uncorrelated with market performance. Others, meanwhile, leverage the boost in capital gains to reinvest in properties of greater value as they attempt to increase their net worth.
1031 exchanges are one of the few ways real estate investors can seek to grow tax-advantaged wealth. Another way is by purchasing fractional interests in a Delaware Statutory Trust.
DSTs provide a unique combination of investment efficiency, flexibility, access to high-quality real estate, and tax benefits. DSTs allow investors to purchase fractional shares in institutional-quality commercial properties that normally would be well beyond their financial means. These passively managed investments can include large multi-family apartment complexes, industrial or medical office buildings, or self-storage facilities.
DSTs investments are pre-packaged and offered by a sponsor, who has performed all necessary due diligence and gathered information pertinent to potential investors, such as rent rolls and financials, inspections, and environmental reports. Financing and a third-party management team are already in place as well.
Investors who invest in DSTs or complete 1031 exchanges can potentially enjoy monthly income as well as seek to grow their tax-advantaged wealth over time through capital and asset appreciation. When it’s time to sell or liquidate real assets, investors often unwind these types of real property investments in their retirement years when they are in lower-income brackets, which can potentially reduce their tax burden. Alternatively, they can will these assets to their heirs, who can receive a step-up in basis that potentially could eliminate the accumulated deferred tax liabilities for the heirs.
Putting it All Together
Investments in real estate provide an opportunity to build a larger nest egg that can be used to close the Retirement Income Gap. Real estate is vastly underutilized in traditional retirement planning. Less than 2 percent of all assets held in employer-sponsored 401(k)s involve real estate, and most of that is invested in publicly traded REITs that are directly correlated to strong stock market performance to generate positive returns.
Countless retail investors have supplemented their incomes by investing in DSTs or completing 1031 exchanges. It’s important to note that investors who complete 1031 exchanges are only deferring taxes on capital gains. Tax liabilities incurred from selling real property are due when the owner decides to liquidate the investment.
The 1031 exchange can be a wealth-building tool for all types of investors, not just high-net-worth individuals seeking to grow their fortunes. Indeed, statistics bear out that it’s primarily main street investors, rather than the wealthy elite, who utilize 1031 exchanges.
According to a 2020 study by researchers at Syracuse University and the University of Florida at Gainesville, the median value of all properties involved in exchanges in both 2018 and 2019 was $500,000, proof that retail investors, not well-heeled institutional investors, are most often completing 1031 exchanges.
Delaware Statutory Trusts and 1031 exchanges are two options available for main street investors to build tax-deferred wealth through investments in real estate. These investments could potentially help you bridge the Retirement Income Gap and avoid having to make drastic changes to your lifestyle if something unexpected occurs during retirement.
About the author: Rob Johnson
Rob Johnson is head of Wealth Management at Realized, a technology-enabled platform that provides investment property wealth management for real estate investors.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Consult with your tax advisor regarding your individual circumstances.
The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. These programs can give no assurance that it will be able to pay or maintain distributions, or that distributions will increase over time.
Got Questions About Your Taxes, Personal Finances and Investments? Get Answers!
Email Jeffrey Levine, CPA/PFS, chief planning officer at Buckingham Wealth Partners, at: AskTheHammer@BuckinghamGroup.com.
Ask the Hammer