Advertiser Disclosure

College Students and Recent Grads, Eliminating Fees, Life Events

When to Avoid a Company 401k

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Man Paying Bills With Laptop

Gone are the days of workers depending upon pensions when they retire. Today, instead of offering defined benefit pensions guaranteeing an employee a monthly payment for the rest of his or her life, employers are moving to more employee-managed retirement savings plans.

Today, more employers offer a 401k plan – if they have an employer-based plan at all. With a 401k, employees make a defined contribution from their income each year. With a pension plan, employees knew exactly how much income they could depend on each month during retirement. Now, it is up to the employees to determine how much they need to save in order to reach their retirement savings goals.

A 401k allows employees to make defined contributions, pre-tax (or post-tax), towards retirement. If you contribute to a traditional 401k, contributions are automatically deducted from your paychecks each pay period, pre-tax. As a result, you don’t pay taxes until money is withdrawn from the account and you cannot withdraw money before 59 ½ without penalties. Some employees offer the option to contribute post-tax in a Roth 401k, so money withdrawn in retirement will not be taxed.

With this change toward employee-directed retirement, rather than retirement guaranteed by the employer, it is up to you to make the best decisions regarding your retirement savings. This could mean it’s best to avoid a company 401k.

Take a look at these situations in which you should not pay into your employer’s 401K, and see if any of them apply to you.

No Employer Match

Many employers provide a match to their employees’ 401k contributions. Employer matches vary greatly by employer, but a common example of this is $0.50 per $1.00, up to 6% of employees’ pay.

Let’s say you earn 40,000 per year at your current job, and your employer provides a $0.50 per $1.00 match, up to 6% of your pay. If you were to contribute the full 6% of your pay annually, you would contribute a total of $2,400 to your 401K over the course of a year. Your employer would then contribute $0.50 for every dollar you contributed, for a total of $1,200 for the year.

In total, over the course of the year your 401K would contain $3,600, and you only would have contributed $2,400 of the balance.

But if your employer does not provide a match, it may be time to reconsider contributing to its 401K plan. Never walk away from an employer match, as it is basically free money, but if your employer does not provide a contribution match, it may be time to consider other options like saving for retirement in a traditional or Roth IRA.

You Have Reached The Contribution Limit

Effective January 1, 2020, the 401k contribution limits are $19,500 if you are age 49 and under. If you are 50 or older, you can contribute an additional $6,500 above and beyond the $19,500 regular contribution, for a total of $26,000. Of course, you are free to contribute less to a 401K, but saving as much as possible for retirement is always best.

Once you have reached the contribution limit on your 401k, you cannot make any more contributions pre-tax, and it is time to consider alternative investments.

One good alternative is a Traditional IRA. Contributions are made to a traditional IRA after tax, meaning that you pay taxes, and then make contributions out of your paycheck. For 2020, individuals can contribute up to $6,000 per year to a traditional IRA if they are 49 and under. You can contribute up to $7,000 per year if you are 50 or older.

Another solution for aggressive savers is a taxable account such as stock index funds. When using taxable accounts such as these, you can expect to pay 15% on long-term gains and qualified dividends. Additionally, contributions to these plans are made after-tax. However, the benefits of using accounts such as these include being able to withdraw from them for things such as children’s college expenses before age 59 ½ without additional penalties and fees.

You Qualify For a Roth IRA

If you employer does not offer a 401k match – or a 401k plan at all – and you meet income thresholds, then a Roth IRA may be an excellent option for your retirement savings.

A Roth IRA allows individuals whose modified adjusted gross income, which you can calculate at the IRS website, is less than $139,000, or married couples whose income does not exceed $206,000 to contribute to their retirement.

A Roth IRA is different from other accounts, though, because of the way taxes are handled. Contributions are made after tax. However, once the initial contribution is made, you enjoy tax-free growth as long as you follow the rules:

  • 49 and under can contribute a maximum of $6,000
  • 50 and over can contribute up to $7,000
  • You can withdraw your contributions (not growth) at any time without penalty

How much can a Roth IRA save in taxes? If you contribute $5,500 per year to a Roth IRA for 40 years, and your marginal rate is 15%, this is what your account’s growth could look like over the course of 40 years:

401k_1

In this scenario, you would have only paid in $230,000 during the entire 40 years you worked. You would have paid $34,500 in taxes from your paychecks.

However, your relatively small investment could grow to $1,189,636 – and you will not have to pay taxes on any of that balance when you withdraw it. If your marginal tax rate stayed at 15% when withdrawing money from your Roth IRA, you could save more than $143,000 in taxes alone.

See how much money you can save with a Roth IRA, and how much money it can save you in taxes here, with Bankrate’s Roth IRA calculator.

High Fees

If your employer offers a 401k without a match, a good way to gauge whether it is a good investment vehicle for your retirement savings is to take a look at the fees. Many times both employees and employers are unaware of just how much fees are costing them. After all, 3% seems like such a small number, doesn’t it?

3% may feel like a very small amount to pay in fees, but this example will show you just how much a small percentage can affect your retirement savings.

401k_2

In this example, the investor is a 29 year old, contributing $18,000 per year to her company’s 401k, and her retirement age will be 65. The current balance of their 401K is $100,000, and fees are 3%.

Just by switching to a plan that cuts fees in half, 1.5%, she could save $801,819.03. Instead of having $1.8 million upon retirement, she could have more than $2.6 million – making for a much better retirement.

You can check out a fee calculator here and find out just how much your fees are costing you!

Even if your 401k has high fees, be sure to consider the employer match. Many times the match will more than cover the fees, making the 401k a good investment vehicle in spite of the high fees.

If You Need Flexibility

401k’s, while they offer tax advantages, and often free money through the form of an employer match, do not offer any sort of flexibility. Contributions are automatically deducted pre-tax from an employee’s paycheck in pre-set amounts, and cannot be withdrawn without serious penalties until age 59 ½.

For many families, saving and investing money is not just about retirement. It is about college, medical expenses, large purchase, and even vacations. Always contribute to your 401k up to the maximum amount that your employer will match, but if no match is available and you need flexibility for other savings priorities, check out some of these options:

A 529 Plan: An education savings plan operated through your state or an educational institution to help families set aside income for education costs. Although contributions are not deductible on your federal income tax return, the investment grows tax-deferred, and distributions used to pay the beneficiary’s college costs come out tax-free. Some states offer tax breaks for 529 contributions, you can find yours here. In addition, there are very few income and contribution limitations, making the 529 plan a great, flexible way to save for college.

A Health Savings Account: An HSA offers individuals and families the opportunity to save money exclusively for medical expenses, and contributions are 100% tax deductible from gross income. For 2020, individuals can contribute up to $3,550, and families are allowed to contribute up to $7,100. HSA accounts holders age 55 and older can contribute an extra $1,000. If using savings for medical expenses if a priority, talk to your employer about an HSA. Not all insurance plans are eligible.

Taxable Investment Accounts: When saving for large purchases or vacations, more flexible accounts are better. As explained above, index funds, mutual funds, or even traditional savings accounts leave the account holder with more of a tax burden, but far greater flexibility for withdrawals. These accounts do not need to be opened through your employer, but can be opened and managed on your own, or with the help of a financial planner.

If your employer offers a contribution match, they are essentially offering you free money, so go ahead a take advantage of the 401k, regardless of high fees or a low income. However, if your employer offers no match, high fees, or you have reached the yearly contribution limit, then it is a good idea to avoid that 401k plan and look into other retirement savings options.

At the end of the day, saving for retirement or other goals is all about you. How much flexibility you need, how much you need to save, and your tax situation. Be sure to weigh all of your options to guarantee that you are making the best decision for you and your family.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Gretchen Lindow
Gretchen Lindow |

Gretchen Lindow is a writer at MagnifyMoney. You can email Gretchen at [email protected]

Advertiser Disclosure

Life Events

Ultimate Guide to Required Minimum Distributions (RMDs)

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

When you reach age 72, the government requires you to begin withdrawing money from your retirement savings accounts each year. This sum, known as a required minimum distribution (RMD), allows the IRS to begin collecting income tax on the dollars you’ve stashed away in tax-deferred accounts such as a 401(k) or traditional individual retirement account (IRA).

What is a required minimum distribution (RMD)?

Regulations governing most retirement accounts state that you cannot leave funds in the account indefinitely. Even if you don’t need the money, the government requires you to begin reducing the overall balance in most accounts by a set sum each year — the required minimum distribution — typically following your 70½ birthday.

The precise amount of each person’s required minimum distribution is determined by the IRS based on life expectancy and total savings. The RMD rule only applies to tax-deferred accounts or accounts that allow people to reduce their taxable gross income each year by the amount they set aside in the plan.

Because tax-deferred accounts provide upfront tax savings, the IRS waits to collect taxes on contributions to the accounts and any subsequent investment gains until the money is withdrawn. Here’s a full list of retirement accounts subject to the RMD rule:

  • 403(b)
  • 457(b)
  • Profit-sharing plans
  • Other defined contribution plans

The rule does not apply to Roth IRAs or Roth 401(k)s, as you’ve already paid income tax on funds contributed to these accounts. Note, however, that once the original account owner dies, Roth IRAs are subject to RMDs.

When do I have to start taking RMDs?

Retirees will need to take distributions by April 1 of the year after they turn 70½. Those with birthdays in the second half of the year benefit from this rule because it allows them to delay beginning taking RMDs for a little longer than those with earlier birthdays can.

For instance, if your 71th birthday is on July 1, 2019, you do not have an RMD for that year since you won’t turn 72 until Jan. 1, 2020, meaning you can wait until April 1, 2021 to take your first RMD. But being born just a day earlier, on June 30, would mean you’d have to take your first RMD by April 1, 2020 (as you’d reach 72 on Dec. 30, 2019).

If you are still working at age 72 and have a traditional 401(k) or 403(b) account with your current employer, you may not have to take an RMD from that account unless you own 5% or more of the company. Review your plan’s exact terms to see if it allows you to wait until you actually retire to begin taking RMDs or if it follows the same 72 rule regardless of retirement status.

Employment, however, won’t help you delay taking RMDs from any individual retirement accounts outside of your employer retirement account, such as a traditional IRA.

You do not have to take your RMD as one lump-sum payment. The IRS allows you to take out the funds in chunks throughout the year too. As long as the total meets the RMD for the year, you’re in the clear.

You’re also not limited to taking only the RMD amount from your account each year — you can withdraw more than that threshold, if you want.

How do I calculate my required minimum distribution?

Just like filing your taxes, it falls on your shoulders to remember to take the RMD once you reach 72. You can do the math yourself (we’ll explain below) to figure out what your required minimum distribution will be, or you can ask for help from a tax professional or financial adviser.

To calculate your RMD, you need to know exactly how much you’ve got saved up in each account as of Dec. 31 of the previous year. Next, use the table below from the IRS to find your “distribution period” score, which is based on your life expectancy.

To calculate the RMD, divide the retirement account balance by the distribution period that corresponds with your age. Repeat this step for each of your accounts to come up with the total amount you must withdrawal for the year. Remember, your account balance will change and the IRS can update its distribution period figures, so redoing this math each year is crucial to ensure you take out the correct sum.

Let’s say you turned 72 in December 2019 and had a balance of $1 million in your retirement account on Dec. 31. You would then find the distribution period that corresponds to your age in Table III or the Uniform Lifetime Table.

According to the table, your distribution period number is 27.4. When you divide $1 million by 27.4, you get an RMD of $36,496.35. That is the minimum withdrawal you must make from that account by April 1, 2020.

However, if you’re married and your spouse is 10 years or more younger than you and is the sole beneficiary of the retirement account, you will need to find your “distribution period” score on this alternate table by locating the spot where your age and your spouse’s age intersects.

For instance, if you turned 72 this year and had that same $1 million balance in your retirement account on Dec. 31, but were married to a spouse who’d just celebrated their 59 birthday, your distribution period number wouldn’t be 27.4, but rather 28.1 to accommodate the longer expected lifeline of your spouse.

And this would mean you’d need to take an RMD of $35,587.19 from that account for the year, or about $909.16 less than you would if you were single or married to a spouse closer to your own age.

What is the required minimum distribution penalty?

If you don’t take your first RMD by April 1 of the year after you turn 72 or your subsequent annual RMDs by Dec. 31 each year, you’ll be slapped with a 50% excise tax on the amount that was not distributed when you file taxes.

That’s a steep fine when you consider that the top tax rate is 37%, which is why it is so important to accurately calculate your RMDs each year, as the tax applies whether you fail to take any money from the account or simply don’t take enough.

For example, if your RMD was $10,000, but you only took out $5,000, you will be assessed that 50% tax on the $5,000 that you did not withdraw.

Remember, if you delay taking your first RMD until April of the year following your 72 birthday, you’ll be required to take two withdrawals in the same year, one for your 72 year and one for your 72 year, which could raise your gross income and move you into a higher tax bracket. To avoid this, you can opt to make your first withdrawal by Dec. 31 of the year you turn 72, instead of waiting till the following April.

Alternatively, you could reduce your taxable income by making a qualified charitable distribution paid directly from the IRA to a qualified public charity, not a private foundation or donor-advised fund. The charitable distribution can satisfy all or part of the amount you are required to take from you IRA and won’t count as part of your income.

If you withdrawal the RMD first, then donate it, this trick won’t work as the money will count toward your gross income.

What if I have multiple retirement accounts?

If you have more than one retirement account, things can get a little more complicated. You still need to take an RMD, but you don’t have to take one out of each IRA account. Instead, you can total the RMD amounts for all your IRAs and withdraw the whole amount from a single IRA or a portion from two or more.

However, you can’t do the same with most defined contribution plans, like 401(k)s. With these accounts, you must take an RMD from each plan separately. One exception to this rule, though, is 403(b) tax-sheltered annuity accounts. If you have multiple of these accounts, you can total the RMDs and withdrawal from a single account.

If you own several different kinds of retirement accounts with RMDs, it’s probably a good idea to seek advice from a tax or financial adviser professional who can help you make the wisest decision for your finances.

I inherited a traditional IRA — what should I do?

While it’s great to be left the generous gift of a retirement account by a loved one, inheriting an IRA comes with its own set of tricky RMD rules that can vary greatly depending on your relationship with the original owner and how you chose to use the account.

I inherited a traditional IRA from my spouse

If you’re a spouse and sole beneficiary, you have the most flexibility in how to handle your new IRA. You can choose to treat the IRA as your own by designating yourself the account owner and making contributions or by rolling it over into an existing IRA account that you own. If you choose this option, you can follow the standard RMD rules — meaning you can wait until you turn 72 to begin taking money from the account.

Alternatively, you can roll the assets into what’s known as an inherited IRA. With this kind of account you can start taking distributions immediately and not face the typical 10% early-withdrawal penalty the IRS applies if you’re under age 59½.

To calculate the RMD you’ll need to take with this kind of IRA, use the IRS’s Single Life Expectancy Table, which has different distribution period figures than the standard table you would use if you were the original account owner. You can opt to use your own age for these calculations or your partner’s age as of their birthday in the year they died, reducing life expectancy by 1 each subsequent year.

But you may not need to take RMDs right away depending on how old your spouse was when they died. If they were older than 72 then you’ll need to start withdrawing funds by Dec. 31 of the year following their death. But if they were younger, the IRS lets you leave the money in the account until your spouse would have reached 72.

I inherited a traditional IRA — but I’m not a spouse

Beneficiaries who are not a spouse are required to move the assets into an inherited IRA and begin taking RMDs regardless of the original owner’s age. If the person passed before age 72 you can opt to withdraw the full balance within the five years following the year of their death. Or you can prolong the payouts by taking RMDs annually based on your age, reducing beginning life expectancy by 1 for each subsequent year, using the Single Life Expectancy Table.

If the original owner was 72 or older, how you calculate your RMDs depends on whether you or the deceased was younger. The lowest age is what you’ll base your life expectancy figure found in the Single Life Expectancy Table on, though you will need to reduce beginning life expectancy by 1 every subsequent year.

I inherited a Roth IRA — what should I do?

The original owner of a Roth IRA never has to take RMDs but that can change when the account passes to a beneficiary. A surviving spouse who inherits a Roth IRA can opt to treat the account as their own, meaning they won’t ever need to take an RMD, if they contribute to the account or roll into an existing Roth IRA.

Non-spouse beneficiaries, however, do have to take RMDs from an inherited Roth IRA, following the same rules as those who inherit traditional IRAs where the owner passed before reaching age 72.

That means these beneficiaries can either withdraw the entire balance from the Roth IRA within the five years following the year of the original owner’s death or begin taking RMDs based on your life expectancy, as outlined in the Single Life Expectancy Table, by the end of the year following the owner’s death.

The final word on required minimum distributions

Whether the retirement account was yours to begin with or you’ve inherited it, calculating the correct RMD amount to withdraw from it every year can be tricky, but spending the extra time to make sure you understand the rules and check your math can pay off big time when you’re not losing 50% of your savings to Uncle Sam in the form of a tax penalty.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at [email protected]

Advertiser Disclosure

Life Events, Mortgage

The Risks and Rewards of an Out-of-State Investment Property

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Mortgage

They say real estate is all about “location, location, location.” That’s especially true when it comes to buying a rental. Where you choose to buy an out-of-state investment property can have a significant impact on your return on investment.

See Mortgage Rate Quotes for Your Home

See RatesSee RatesTerms Apply. NMLS ID# 1136

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

For example, in a state like New York, where the median mortgage exceeds the median rent by nearly $250, buying a property to rent out doesn’t make much financial sense. If you consider buying rental property in a different state, such as North Carolina where rents in the city of Charlotte top mortgages by $84 per month, you’ll net a profit instead of a loss every month your tenant pays rent.

Before you start the interstate home search process, you should know the risks and rewards of out-of-state investment properties.

Potential rewards of buying an out-of-state investment property

Very often, the primary reason to buy an out-of-state investment property is rental properties where you live are too expensive. In some cases, you may decide to hold onto an existing home when moving to another state. There are some other more strategic reasons that we’ll cover next.

Diversify your real estate assets

Real estate markets rise and fall. During the housing boom of 2003 to 2007, many of the “sand” states, such as California, Arizona, Florida and Nevada, experienced home price appreciation at rates well above historic levels.

Investors learned a painful lesson in the danger of not diversifying when the housing markets in those states crashed during the housing crisis. Investors who had investment real estate concentrated only in these states lost big, while those who spread their portfolios out to other states fared better.

Purchase future vacation or retirement residences

If prices and rents are competitive in a state you’ve always wanted to vacation in, you may want to purchase the property first as a rental and allow tenants to build some equity for you while you generate income. After a few years, you may decide you want to spend a few months a year vacationing in the home and rent it out seasonally with a rental plan from a service such as Airbnb or VRBO.

Alternatively, you may live in a cold-weather state, such as Massachusetts, and want to retire to the warm winters of Arizona. You could put the wheels in motion on your retirement plans by buying a rental property there first that has the amenities you would want in a home for retirement.

Once you’ve pocketed some rental income and equity from renters, you can pack up for the cross-country move into the rental, throw out the snow shovel and enjoy wearing shorts instead of parkas during the holiday season.

Buy where the laws suit your rental strategy

Short-term rentals have become very popular for real estate investors, but they face legal challenges in some places. For example, New York City subways are covered with signs warning riders to avoid short-term rentals.

If you are interested in renting out your investment property through a service like Airbnb, buying in a state that has more flexible laws about short-term tenants is your best bet.

Net more income monthly with lower property taxes

According to a recent LendingTree study, homeowners in San Jose, California, paid on average $9,626 in property taxes each year. In Salt Lake City, homeowners pay only $2,765 per year — which means you’d have to get an additional $567 per month in rent in California just to cover the property tax expense before you could make any profit.

Risks of buying an out-of-state investment property

Like any investment, there are risks associated with buying out-of-state rental properties. We’ll discuss those next.

Long-distance property management problems

If you have a rental in the city you live in, you can deal with an unexpected tenant move-out or a late-night plumbing problem by driving over to the property and taking care of the issue yourself. But you’ll need to make some decisions about how to manage an out-of-state rental.

If you hire a property management company, they’ll take 8% to 12% of your monthly rent as a fee, eating into your monthly rent profit. If you self-manage, you’ll need to make sure you build relationships with local handymen, roofers, plumbers and pest control professionals so you have their numbers handy if a tenant emergency comes up.

State laws that restrict how you rent your property

Short-term rentals, such as Airbnb, may be a great way to generate a higher monthly income than you would get with a 12-month lease, but some cities and neighborhoods aren’t too keen on having a lot of different people coming and going through a nearby house. If the laws prohibit short-term rentals in an area you’re interested in, you’ll have to crunch the numbers to see if market rents for long-term leases provide you with a good return on your rental investment.

What to look for when considering an out-of-state investment property

When you’re buying in another state, take extra precautions to make sure you understand everything about the local housing market, building standards and how the local economy is doing before you start making offers. The last thing you want to do is end up with an out-of-state money pit.

Get a thorough home inspection

No matter how nice the home may look in pictures or at an open house, there can always be problems beyond the smell of new paint and carpet. Building standards and practices may vary from state to state and city to city, and you don’t want to be caught by surprise because you didn’t know polybutylene pipes behind the walls of homes built in Tucson, Arizona, have been known to burst without warning.

A good local home inspector will also help you understand whether a property has been built and maintained according to local building standards and identify any issues, such as an unpermitted room addition, that could cause you trouble with local housing inspectors down the road.

Interview several property management companies

Depending on the town, you may find very high-tech, organized property management shops with decades of experience or small mom-and-pop shops that offer real estate property management services. Either way, you want to know what they do for their fee. The graphic below provides a list of questions you should ask to make sure the property manager is a good fit for your out-of-state rental.

  • How many rental units do you manage? Ideally, you want a manager who has between 200 and 600 rental units. This indicates that the management company has a solid enough client base to understand the local market but not so extensive that they won’t be able to handle managing yours.
  • What experience does your company owner have managing rentals? When the long-distance plumbing hits the fan you don’t want to be dealing with a company that’s never managed rentals. There is no college of rental property management, and you don’t want to have your rental managed by someone who’s still learning the ropes.
  • Are you actively investing in real estate in your market? If you are buying in a housing market you’ve never purchased in, you may want to have a property manager who understands the nuances of the local rental market. This is especially important intel when you’re dealing with an out-of-state investment property in a neighborhood that may be going through changes that only an experienced local investor would know about.
  • How do you collect rent? In order to track cash-flow of a rental property, you should be able to easily track payments. The best method is through an online payment system that gives you real-time information about any late payments. If you took out a mortgage to purchase the rental property, you want to know as early as possible if a tenant is going to miss rent, so you can move money to cover the mortgage payment.
  • What is your average vacancy time on rentals? The correct answer should be two to four weeks. An experienced property management company should have the marketing and rental pricing know-how to make sure your property is not vacant for more than a month. It’s bad enough having a rental vacant, but when it’s out-of-state, you want to know the company managing the property has a track record of getting renters quickly to minimize the expenses you incur when a rental is without a renter.On the other hand, a property manager that rents out your place in less than two weeks may be pricing it too low.
  • How do you handle maintenance and repairs? It’s not uncommon for a property manager to have “preferred” vendors to help with the inevitable issues that come up with maintaining and repairing a rental. You’ll want to get a list of these preferred providers and keep track of their expenses.Also be sure to put a cap on the cost of repairs that can be done without your authorization. You should trust the company to handle a $100 fee, but you may want to cap them on anything more than $200 so you can have a chance to see if you need a second opinion with a different vendor.

Track property tax trends in the neighborhood

Property taxes are a fixed expense you can’t get around paying, so be sure to track the last five years of property taxes to see what the average increase has been. If you’re seeing an acceleration in the tax rate, figure that into your return-on-investment analysis, so you don’t end up in a situation where your monthly expenses are more than the rent you’re taking in.

Make sure you understand the rental market in the area

Rental markets ebb and flow as new homes are built, new employers set up shop nearby or new schools are built in the area. A good property manager or experienced real estate agent should be able to give you a good idea of where the market is headed with a comparable rental analysis.

When you bought your first home, you may have gotten a comparable market analysis (CMA), which analyzes what homes are selling for in the area you’re thinking of buying. A comparable rental analysis looks at rentals nearby to give you an idea of what your monthly income is going to be.

If you finance the property with a mortgage, you’ll likely need a rental analysis form 1007, which is an additional report in a residential home appraisal that provides an opinion of the market rent for the home you’re buying. In some cases, the appraiser’s projected market rent can be used to help you qualify for the new mortgage, even if you don’t have a lease on the property you’re buying.

Special mortgage considerations for out-of-state investment properties

If you’ve been buying investment property in your hometown, you already know financing a rental property comes with higher down payments and interest rates. There are a few more factors to consider.

Are transfer taxes due and who pays them?

Depending on what state you are buying property, transfer taxes may be charged for you to take ownership of the property you are buying. Unlike property taxes, these are a set lump sum percentage of your sales price, added to your closing costs.

Transfer taxes are often paid by the seller, but in some cases they may be payable when buying a home, adding to your total closing costs. It’s also good to at least know how much they are so they don’t end up being one of those hidden costs of selling a home. In places like New York City, that could mean an extra 1% to 2.625% of your sales price subtracted from your profit, in addition to real estate fees that usually run between 5% and 6%.

Are you buying in an attorney or escrow state?

Depending on where you purchase your rental property, you may need an attorney to handle your contract negotiations. That means higher costs than you’ll find in an escrow state, where an escrow offer can handle the signing usually at a much lower cost.

Are you buying in a community property state?

If you’re currently married or have a domestic partner, the community property laws could affect what happens to the property in the event of a divorce. Community property states require a split of equity down the middle, whereas the equity can be split up in negotiable amounts in a non-community-property state.

Final considerations

A little due diligence and research will help you avoid unpleasant surprises if you’re considering buying an out-of-state investment property. While many real estate companies offer “virtual tours” of homes, there’s nothing like an in-person tour to soak up the light, views, smells and feel of a home before you buy it.

If you can, budget enough time to take a trip to the state you’re considering buying in to inspect the top contenders before you start making offers on an out-of-state investment property.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here