Rental Property vs. IRA

Saving for retirement is an important and ongoing part of most workers' financial lives. Among the many options are personal investments in rental properties and individual retirement accounts (IRAs). Workers can combine these investing sources with others to ensure they have enough money to retire on schedule, as each option has its risks and drawbacks.

IRA vs. Real Estate: Making Money

Rental property investments and IRAs can both produce additional money for retirement. However, beyond this basic shared function, they are very different investments.

An IRA allows workers to make regular contributions over time, whether from paycheck withholdings or personal contributions. Typically, the Roth IRA is usually funded by after-tax earnings, while other kinds of IRAs, particularly the traditional ones, tend to be funded by pre-tax contributions. The IRA manager then invests that money in a broad range of securities and allows the worker's money to grow along with the economy as a whole.

On the other hand, a rental property allows an owner to collect rent from tenants each month, usually funding a mortgage loan on the property. However, some owners opt for a property manager to take charge of the rent collection. In addition, with time, the property owner builds up equity before selling or eventually owning the property outright.

IRA vs. Real Estate: Drawbacks

IRAs are relatively safe investments, but they do carry some risk. The major risk of an IRA is that an owner earns low returns and would have been better off investing elsewhere, such as in mutual funds or bonds.

Also, some IRAs have contribution limits, which prevent owners from setting aside additional money for retirement as they can. For example, a Roth IRA currently prevents anyone from investing more than ​$6,000 – or $7,000​ if 50 years or older. The same applies to traditional IRAs.

In addition, IRAs also charge penalty fees to owners who withdraw their money early. Generally, anyone who withdraws from an IRA before reaching ​59.5 years​ will have to pay an additional 10 percent ​penalty.

On the other hand, rental property owners can sell whenever they like, before or after retiring. That said, real estate investments also have their share of drawbacks.

Rental property investments with an eye on retirement income have potential drawbacks. Buying rental property is subject to the risks associated with buying real estate.

One of the most significant risks is that the buyer may get a mortgage loan with a variable interest rate that rises over time depending on the financial index it is pegged on. If that happens, the mortgage could become unaffordable.

Also, the property itself may lose value if the demand for rental housing in the community falls. And even if the property maintains its value, an owner may have trouble attracting tenants who pay their rent on time.

Furthermore, rental property investors are also responsible for maintenance, property taxes, and repairs, which cost time and money even when a rental property is vacant.

IRA vs. Real Estate: Tax Considerations

Both rental property and IRAs can have significant tax effects on their owners.

Some IRAs allow owners to contribute money before taxes and only pay tax once they withdraw the money, making it a tax-deferred investment product that saves money.

On the other hand, a rental property allows an owner to deduct depreciation of the property, along with improvement costs, from taxable income each year. That helps in reducing the owner's tax liability.

Rental property may also qualify the owner for a mortgage interest deduction for further federal income tax savings while working and during retirement.

Is real estate better than IRA? Well, it depends on what you are looking for in an investment. Both real estate and IRAs have their fair share of advantages and disadvantages. It would be wise to consider them in relation to one’s financial goals before deciding what to do. There is always the option of investing in both.