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A Real Estate Investment Trust (REIT) is a trust that makes money from income-generating real estate. You can think of it as the real estate version of a mutual fund. There are also index funds of REITs that allow you to own a low-fee, broadly-diversified portfolio of REITs (and therefore of real estate) similar to the way you can own stocks or bonds via index funds. Vanguard’s VNQ is an example of a REIT index fund.

How do REITs work?

You can read more here, but in short, REITs finance, lease, or own real estate, and distribute any profits as dividends to investors. Many REITs trade like stocks or (when bundled together) like mutual funds. They essentially have to pay out the bulk (90%) of their income each year to shareholders, hence why their income generation is high relative to investments like stocks that are not required to distribute income.

How are REITs taxed?

REIT dividends are taxed at regular income rates

One negative aspect of REITs is that instead of their dividends being ‘qualified’ for long-term capital gains rates on shares held for a while (like stock funds), the income is taxed at regular income tax rates (same as for bond funds, or bank interest.)

Per the Tax Cuts and Jobs Act of 2017, you might get some of that back in the form of the 20% QBI deduction. Say your tax bracket is 24%. 20% off that equals an effective rate on REIT dividends of 21.6%, which is still higher than the 15% long-term capital gains/qualified dividend bracket that you’d be in for stocks you’ve held for over 60 days.

Because of the higher income generation of REITs vs stocks combined with the dividends being taxed at regular rates, you probably want to have REITs in your retirement/tax-advantaged accounts, and have more stocks in your taxable funds to balance out whatever asset allocation you’re going for.

Other forms of (non-dividend) REIT income

You can also have capital gains (long-term or short-term) from REITs that are taxed the same way as capital gains generally (e.g.: for stocks), as well as ‘return of capital’ distributions which would lower your cost basis at the time of sale. These forms of income seem to be rare for most publicly-traded REITs.

How have REITs performed vs stocks or bonds?

Trying to use past returns to predict the future is often a fool’s errand for financial markets, but the longer back you look at broad asset classes the more helpful it probably is.

For Vanguard’s REIT fund (our proxy for the REIT sector), the results are not very favorable compared to the total US stock market (light blue line below) or even an overall US bond fund (Vanguard’s BND, the yellow line) given that the bond fund was MUCH less volatile compared to the REIT fund, despite price appreciation that was only slightly less over the ~16 year period that I could get data for (when all 3 funds were in existence together.)

I should note that this chart from Yahoo! Finance understates the total returns for both the bond fund and the REIT relative to the stock fund (VTI) since the dividends in those funds were likely higher than those from the stock fund, and reinvested dividends aren’t shown in this chart, just the total (capital gain) return.

Even so, I doubt it would make enough difference to change the conclusions: Y-charts shows 5-year total returns of 35% for VNQ vs 13% shown over the same 5-year period in Yahoo! Finance due just to price movement, so any extra ~4-5% per year isn’t shown. VTI probably had dividends of about 1.5-2% per year during the past 10 years, so REITs’ should have an extra ~30-40% of absolute return tacked on relative to VTI.

Yahoo has 3-year trailing total returns (as of 1/12/2023), and these showed 0.60% per year for VNQ (REITs), 7.40% for VTI, and -2.33% for BND (the negative returns were due to interest rates rising somewhat dramatically– compared to recent history of very low interest rates– in the past year or two.)

Should I have REITs in my portfolio?

I don’t see any reason to. No past data of returns & risk/volatility will ever be ‘conclusive’, but the long-run returns of real estate vs stocks helps cement my belief that individual investors can prudently ignore REITs and just use a mix of stock and bond index funds (with cash for needs in the next year) for their portfolios.

You have real estate exposure already

Most investors already have significant exposure to real estate in the form of a personal residence, which is another reason to skip REITs. (Yes, I know, your single residential property isn’t the same thing as a basket of many commercial properties, but you’ll still be impacted by national real estate trends on top of local market conditions.)

Businesses like those owned via the total US stock market also have commercial real estate in the form of office, retail, and manufacturing space, so you have some exposure to commercial real estate already through stocks.

Conclusions

Keep it simple and skip REITs. Stick to my recommendation of just bonds & stocks in the form of low-fee, diversified index funds. But, if you really want to own real estate as part of your financial portfolio, use a low-fee REIT index fund like those from Vanguard.

Key points on ABLE accounts

ABLE accounts allow the disabled to have assets up to $100,000 that don’t count against the $2,000 resource limit test used to determine eligibility for state & federal aid programs like SSI (cash assistance from social security), SNAP (food stamps), and Medicaid (health insurance for the poor.)

The ABLE National Resource Center has a lot of great detailed info to help you through the process of application & selecting the best ABLE plan for you. In general, if you pay state income tax, you’ll be best off picking your state’s plan since you can deduct your contributions from your state (but not federal) taxes.

Who is eligible for and can manage ABLE accounts?

People who developed a disability–including blindness– prior to their 26th birthday that is expected to last indefinitely or has already lasted for a year are eligible for ABLE Savings accounts, and they are also the account owners and beneficiaries. However, “authorized agents” for the disabled person can be the person actually opening, funding, and managing the account on behalf of the disabled beneficiary. This is typically a parent or guardian, but many states allow for multiple authorized agents with varying levels of access.

“In general, individuals are eligible for an ABLE account if they are already receiving benefits under Supplemental Security Income (SSI) and/or Social Security Disability Insurance (SSDI). If not, they may still be eligible if they certify that they are blind or disabled and have a written diagnosis of their condition by a licensed physician. Under all circumstances, the onset of the disability must have begun prior to age 26.”

Until very recently, disabled individuals found themselves in a delicate situation when it came to their long-term financial security. The same often applied to families raising children with disabilities. While they might qualify for state and federal aid programs, such as Supplemental Security Income (SSI), Supplemental Nutrition Assistance Program (SNAP), and Medicaid, they could only receive the full benefits of each if their assets were less than $2,000. Since these programs often fund access to assisted living technologies and services, healthcare, and transportation, disabled individuals were essentially forced to remain poor or lose their benefits.

Luckily, this antiquated approach is slowly changing, thanks in large part to the Achieving a Better Life Experience (ABLE) Act. The ABLE Act amended parts of the federal tax code beginning in 2015, allowing states to establish tax-advantaged savings programs for individuals with disabilities and their families. Importantly, the assets don’t count against the $2,000 resource limit for SSI until they total $100,000.

https://www.fool.com/investing/2018/07/05/what-are-able-savings-accounts-5-things-you-should.aspx

Advantages of ABLE accounts

Money up to $100,000 ($100,000 is the limit in Washington state, but in some states, it’s higher.) can be shielded from the limits imposed by Social Security for determining SSI payments. Investments in the account grow tax-free and are tax-free upon withdrawal if spent on ‘qualified disability expenses’, similar to how a 529 plan works. In fact, you can transfer assets from a 529 plan into an ABLE account, with some restrictions.

In Washington state and generally (double-check with your state just to make sure), there’s no limit on ABLE funds for eligibility for Medicaid, which is awesome.

What can you spend ABLE money on?

You must spend ABLE money on “qualified disability expenses” (QDE) which broadly include any expense related to the disability or blindness of the beneficiary. In practice this includes:

• Living expenses
• educational expenses from preschool through college, and includes tuition, books, and supplies.
• transportation, like bus passes, moving expenses, or the purchase of a vehicle
• job-related training expenses
• Almost any medical expense, including insurance costs, long-term support, nutrition management, communication services & devices, and more.
• Assistive support expenses like a computer for a child with autism.
• Various miscellaneous expenses like legal fees and funeral expenses.
• Housing like rent or a home purchase can be considered qualified, but keep in mind they might impact SSI eligibility, so do your homework there.

Many state plans offer debit cards that can be used to spend directly from the account. Washington state charges a small monthly fee per debit card iisued of $1.25/month (no transactions fees when using the card, however.)

Who can contribute to an ABLE account, and how much?

Anyone can contribute to an ABLE account, but the total for all contributions from all people– including any 529 plan rollovers– combined for a single beneficiary can’t exceed $16,000 in 2022, with some exceptions for those below the federal poverty limit for 1-person households. If you pay state income taxes in the same state that the ABLE account was established in, you can deduct your contributions from your state (but NOT federal!) income taxes. Washington state has no income tax, and California’s plan does NOT allow state income tax deductions, but the funds do accumulate tax-free and if spent on qualified expenses, are distributed state (and federal, like all ABLE plans) tax-free.

Also, note that you can only have one ABLE account per disabled beneficiary. In Washington state, only one Authorized Legal Representative is allowed (other states might allow more than one authorized agent.)

From https://www.finra.org/investors/learn-to-invest/types-investments/saving-for-education/able-accounts-529-savings-plans :

• The disabled ABLE account beneficiary can also contribute their employment income to their ABLE accounts in excess of the annual contribution limit, up to the prior year’s individual federal poverty level. For 2022, that was a max of $12,880 in 2022.
• Designated ABLE account beneficiaries may now be eligible to claim the Saver’s Credit.

What state’s ABLE plan should I choose?

Try this comparison tool to look at 3 state plans together. Include your home state. Some states, including Washington state, only allow residents to open plans there. Oregon & California, for example, each have plans open to all US residents.

What investments should I choose within my ABLE account?

Choose low-fee index funds like those offered by Vanguard if your plan has them (Washington state’s does), preferably in the form of a ‘target date’ option that automatically adjusts– or at least rebalances– between stocks and bonds. I assume here that the beneficiary expects the funds in their ABLE account to last over their lifetime. If instead they planned to use all the ABLE money in just a few years, a more conservative investment option should be used.

For Washington state plan participants, I recommend the ‘ABLE Aggressive’ option which is a mix of 84% stocks and 16% bonds for young-ish beneficiaries, like those under 40 or 50. For those 40 – 50 or older, the 50-50 ‘ABLE Moderate’ portfolio is a good one.

For those 70 or older with very limited risk tolerance, the ‘ABLE Conservative’ 80% bonds – 20% stock plan can be used, or for those that expect to exhaust all the ABLE funds in a few years and aren’t planning on using it for life.

For California ABLE plans, the … are good.

Note that you can only make changes to your ABLE investment choices twice a year, the same as for 529 plans.

Can an ABLE account or 529 plan be rolled over to another ABLE account?

Yes, you can roll one ABLE plan over to another as long as the authorized person stays the same, and the beneficiary either stays the same OR is in the eligible family members list. These are the exact rules for Washington state ABLE rollovers. Other states might vary:

• “An eligible Beneficiary can only have one ABLE account open at any
  time, except for the 60-day grace period for closing an ABLE account
  following a rollover to a new ABLE account.
• If there is an Authorized Legal Representative (ALR) on the old ABLE
  account, they must be the same on the new account. If you would
  like to change the ALR, please do so on the old ABLE account before
  completing this form.
• The Beneficiary of the new Washington State ABLE account must
  remain the same as the beneficiary of the old ABLE account or be an
  eligible “Member of the Family” (brother, sister, stepbrother, stepsister)
  of the beneficiary of the old ABLE account.
• A rollover from one ABLE account to another qualified ABLE account
  for the same beneficiary can only occur once every 12 months.”

Also, 529 plans started for education purposes of even a different beneficiary– say, you, or a child without a disability– can generally be rolled into an ABLE account per the ‘family member’ rules (unless the 529 plan was funded with a UTMA/UGMA gift to a minor, in which case the beneficiary can’t change.) This is subject to the ABLE plan contribution limits however, so if you have a large balance in your 529 plan, you may have to do the rollover in pieces ($16,000 at a time for the 2022 ABLE contribution limit.)

What happens to any unused ABLE funds when the beneficiary dies?

“Unused funds pay Medicaid. If the account owner dies with funds in an ABLE account, those funds must be used (in this order), to pay any outstanding qualified disability bills including funeral expenses, to provide payback to Medicaid for all Medicaid benefits received, and then to be distributed to the account holders legal beneficiaries.”

This means in practice that if the ABLE beneficiary received a fair amount of Medicaid services, there might not be much if anything left for beneficiaries, so keep that in mind for estate planning purposes.

Other kinds of accounts for disabled people

A Special Needs Trust is often used as well, but that generally requires legal fees to set up, whereas an ABLE account can be funded for as little as $25 with minimal annual fees ($35/year in Washington state.)

In Part 1 we discussed the ‘soft skills’ behind financial success to teach your kids. In Part 2 we went over some tactical tips including building their credit score and saving for education.

Opening a bank account for your minor child

In the US, a person must be an adult (18+) to have a bank account in only their name. However, minor children can often have their parent or guardian open a joint account with them. (Check with your state, as this apparently depends on state regulations as well as what individual banks or credit unions offer.) Opening a bank account with your child’s name on it is a great way to introduce your child to the concept of saving, interest, and later, investing. Plus, I think it helps make them feel like a responsible adult to be able to, say, walk into a bank and deposit a check from Grandma, write a check to pay for something. When they’re high school-aged teens they can move on to direct depositing their part-time job earnings and using a debit or ATM card responsibly.

So, what bank account to choose? Many banks offer accounts tailored for children and their parents. The first major decision you should make is whether you want them to open a bank that has physical branches or an online-only bank like the ones I recommend.

Physical banks for young kids

Maybe I’m old-fashioned, but even though I try never to set foot in a physical bank if I can help it, I think there’s value in teaching your children to use the expensive relic that is traditional banking. If nothing else, being comfortable in adult institutions is both fun and an important part of growing up. So, if your child is pre-high school, I recommend opening an account at a good physical bank with a local branch near you.

If you use a physical bank (still? :)), then check there first if you like them since it’ll be most convenient for you for your kid to bank where you do. Washington residents should try BECU for kids. (I hate their web technology, but they–like most credit unions– have good incentives and low fees and friendly service.) Credit unions in general are a fine choice if you need an in-person bank for no-fee, moral banking for kids and adults alike.

Nationally, Chase seems to be a more honorable Big Bank than the incompetent Bank of America and the outright-fraudulent Wells Fargo. You can open a Chase kid’s savings account when they’re 6 – 17, or a teen co-owned account when they’re 13 – 17.

Online banks for working/spending teenagers

Once your child is old enough to have more responsibility over their own spending, and especially once they’re earning their own money, you should move them along to the best kind of bank they can have, which means an all-online one with low fees, high automation, and a good interest rate on savings.

I have so many clients still using awful banks like Bank of America or Wells Fargo for the simple reason that– in their words– “it was the first bank I ever had”. Don’t let this be your child.

Ally Bank is probably my top online choice for adults, but as of writing they do not allow minors to be joint account holders.

Capital One— which I use and recommend– offers a Kid’s Savings Account as well as a Teen Checking Account that comes with a debit card. Go with them when your child is ready for direct deposit + a debit/ATM card!

What to tell your kids about banking?

Explaining how checks, deposits, and interest work are all good things to do. Additionally, talk about avoiding overdrafts (make sure your child’s account either has overdraft protection off so with auto-declines in place, or take advantage of setting up free savings transfers that many banks and credit unions offer at no cost.)

Teach them to save up for a big goal like a large purchase using allowance or other gifted funds when they’re young. When they have incomes of their own, teach them to always put aside some portion of it for their futures. When they have earned income from wages, help them open up a Roth IRA.