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Fighting Inflation with a 401(k) – Episode 331

Adam Talks
9 Minute Read

In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses the rising cost of living due to inflation, and how your 401(k) can help absorb some of these costs.

Prices are rising. How you can fight inflation with your 401(k) plan. Hey, everyone, Adam Bergman here, tax attorney, founder of IRA Financial and thanks for joining me on another episode of Adam Talks.

Want to talk inflation. We are in a funnel of higher prices. So I’m going to start off with some examples of inflation, which I’m sure you guys are all experiencing, just like me, whether you’re pumping gas, whether you’re shopping at the supermarket, buying clothes, maybe in the market for a car. You have certainly experienced the shock of looking at the price, whether it’s, again, going to a store or restaurant. I was shocked, though. I went out for dinner with my family a few weeks ago and I just looked at the bill. I couldn’t believe it. And this was a restaurant I’ve been going to for years. And I spoke to one of the waiters that I know, and he said, yeah, we just literally increased our prices by 20% across the board. We actually printed new menus. So he said, listen, prices of food, of produce have all gone up tremendously. We just need to survive.

So, want to talk numbers and then talk about some options to use your 401(k) in a way tax efficiently to maybe pay and help absorb some of these costs. So let’s just start with basic numbers that came out a couple of weeks ago from the CPI Inflation Report back in February.

So here are some numbers. Prices in February increased 0.8% according to the Bureau of Labor Statistics, higher than the 0.6% increase in January. The price for goods and services increased 7.9% from February 2021, accounting for the highest inflation rate since January 1982. God, I was only seven years old.

Common household purchases, including food and clothing, the gas have gone up significantly. Here’s some examples. Meat, poultry, fish and eggs: 13% over the past twelve months. Fruits and vegetables: 7.6%. Electricity: 9%. Furniture and bedding: 17.1%. Women’s dresses: 13.5%. Glad I got boys. Jewelry and watches: 4.2%. Rent and primary residence: 4.2%. Gasoline. We’re at some of the highest prices on record. So back in now, I live in Miami and I’ve seen close to $6 a gallon across the country. It’s around $4.20-$4.30, which is, again, an all time record.

Yeah. Does the conflict in Ukraine have something to do with it? Sure, but we’re in probably for some high fuel prices. What about vehicles? So, listen to this. Because of the pandemic and supply chain issues, used cars and trucks saw 41.2% price increase from February ’21 to February ’22.  41% for a used car or truck. Crazy, right?

So also, in terms of regions of the country and price increases, the South saw an 8.4% increase or the Midwest about 8%.

Okay, so going back to food, I have some examples here I just saw actually in a New York newspaper. So I’m going to share some. These are from New York Post this Sunday. So, just people are preparing for Easter.  Easter is around the corner. Basically, Cadbury eggs, a four pack, went from $2.50 to $3.99. Jelly beans went from $3.99 to $4.99. Hershey Bar went from $0.99 to $1.25. Okay, this is if you look at the Easter basket, Americans are stuffing sticker shock prices surging by 24% since 2019 compared to an overall 9% rate during the same period. Eggs $1.55 to $2.49. Easter egg kit $6.99 to $7.99. Kit Kat bar $0.99 to $1.25. Reese’s Cups $2.99 to $3.99. Pepsi Ten Pack $3.99 to $4.99. Wicker Basket $8.00-$9.00. So the total then was $36.98; now it’s $45.93 from ’19 to ’22 – so a couple of years.

But just wanted to give you a range of kind of the prices that we all can expect. Yeah, this is New York prices, but this is happening across the country. So now that we understand inflation, we know we’re at the highest inflationary points since 1982. What can we do to get ahead of this or at least survive it? We’re all dealing with higher costs, got tax time coming along; what do we do?

So I mentioned 401(k)s, a couple of options here. The 401(k) has a loan feature. So whether you work at a company that offers 401(k)s or if you’re self-employed and have the ability to set up a Solo 401(k), most 401(k) plans offer a loan feature. The way loan feature works is you can borrow $50,000 or 50% of your account value, whatever’s less, and use that for any purpose.

So, if you have $20 grand in your plan, you can borrow $10,000. If you have $200,000, you can borrow $50. Okay. And you can pay that loan back over five years, at least quarterly at a minimum interest rate of 3.25% – the prime rates. Prime will go up because of interest rates. So this may be a good time to lock in a loan. Actually, the prime rate just went up to 3.5%. Okay. So it’s up from 3.25% and it’s going to climb. So if you’re thinking of doing a 401(k) loan, this could be a good chance because as interest rates go up and they will continue to go up over the coming months, that prime rate will drift up. So this could be a good time. You don’t have to take it all at once, right. So if you have $100 grand in your plan, you can borrow $50,000 or 50% of your account value, whatever’s less. Use that for any purpose. So you have the opportunity to take multiple loans. A lot of plans allow for multiple loans.

So, maybe you have the ability to take 50,000, but maybe you only need five or seven or ten. So you just want to make sure you’re doing a few things: paying back the loan payments timely so you can have it drawn from payroll. Or if you have a Solo plan, you could just pay it back. It’s generally quarterly. The lowest rate, as I mentioned, is 3.5%.  It’s a five-year straight line loan. So you can’t do balloon payments. The payments are set periodically over a five-year period. Okay.

The advantage:? Tax-free penalty-free use of the money. Don’t pay tax, don’t have to pay penalties on the money you take. The downside is obviously that money is out of your plan, so it’s not growing tax deferred. You’re spending it and make sure you pay it back, because if you don’t, it’s subject to tax the outstanding amount. So if you took $10,000 out and you only pay back three, and then you missed payments and you don’t correct them within the timely period of the year, you technically would owe a taxable distribution of $7,000 based off that example. Plus, if you’re under 59 1/2, a 10% early distribution penalty.

So you want to make sure you’re making the payments back. The advantage is, again, you get to use the money. You can use it on anything you want doesn’t have to be used for investments. You could use it to help pay for Easter, for food, for rent, for gas.

The cost of going to work every day is getting expensive, right? A lot of people are working from home, but not everyone has that luxury. So if you’re not working from home, the cost of fuel have gone up considerably, in some cases 75% to 100%, depending on where you live over the last six to ten months. That’s a lot of money. If you’re driving 30, 40 miles a day to get to work, it could be an extra $50-$60 a week. That adds up.

So even if you need maybe $1,000, $2,000 from your 401(k), you don’t have to take it all. Let’s say you got $12,000 in a 401(k). You can borrow up to six, maybe take $1,000 out and say, you know what? My cushion. I don’t have to run up a high credit card bill. I can maybe pay down some credit cards and then I get some extra cash flow that can use to pay off high gas prices or deal with Easter or I need to buy my daughter a dress for prom. Whatever it is, you have a little bit of a cushion and then you obviously want to make sure you’re paying those loan payments back. Again, five years, right? You take $1,000, 3.5% is not a lot of money, right? Your monthly payments are going to be quite low, so you don’t have to worry about a cash flow crunch.

But Solo (k)s if you’re self-employed, you don’t have a plan, you don’t need a full-time business. It doesn’t need to be a billion dollar business. Mentioned it before, you can sell shoes on eBay or baseball cards on eBay or sell art on Etsy or babysit, as long as it’s an employer-employee relationship where you’re not just babysitting for your parents, but you’re actually doing it for a third party. You’re selling goods, even if you’re just making a few hundred bucks a year. Technically, you have access to a 401(k).

So, if you have access to a Solo 401(k); if you only make $1,000, you’re going to be limited on how much you can contribute to the plan. Generally, up to that $1,000. But, if you have an IRA, you can roll it in and then borrow against it. IRAs do not have any loan features, but if you have an IRA and you need some cash because you are in a bind, there’s something called a 60-day indirect rollover. And the way the 60-day indirect rollover works is once every twelve months, you could take all your IRA money out, use it for any purpose, but you must return it within 60 days. Okay, so that gives you some leeway to kind of make some use of that cash.

You got to make sure if you take the cash out, you have to return it within 60 days. You can only do that once every twelve months. Not a year, but twelve months, it’s not a calendar year. Take it out in February. You only can do it again after next February.

And you must return it because if you don’t, it’s subject to tax and a 10% penalty if you’re under the age of 59 1/2. So, just something to be cautious about.

Those are probably the two best ways. Obviously, cashing out your IRA and paying tax and a 10% penalty is tough. Leakage in a retirement plan is very painful because you are losing in multiple ways.

Number one, you’re losing because you have to pay tax, penalty up front. Number two, you’re losing the power of deferral and compounding returns because your money is not going to continue growing without tax because you’ve now leaked it and used it personally. And once you pass that 60-day window, you’re done. You can never put it back into the retirement plan. So be very careful with leakage. The Solo 401(k) loan is a great way to grab some money.

You don’t have to take the maximum; a lot of plans, especially if you have a Solo plan, you can do multiple loans, even up to 20 loans, so you can take $1,000 twenty times. If you have an employer plan, you work for Tesla or Apple, you may have some caps on how many loans you can do, but you’ll generally have a loan feature.

Now, if you have a Solo K with TD Ameritrade or Schwab or some of these big institutions, they’re likely not going to give you a loan option. But you can always come to IRA Financial or some other document 401(k) fintech document provider, and we can help you move those funds over tax-free and then borrow against them. So again, I’m not saying you should borrow, but everyone is in a different situation. There’s no shame in borrowing from your 401(k). The shame is not paying it back okay? You just want to be super careful that you’re taking just enough out that you need not overborrowing. So you can make those quarterly or monthly or biweekly interest payments, loan payments back; principle as well. And we have loan calculators on our website if you have questions. But it’s just a nice way to get tax-free, penalty-free use. You are paying yourself back at 3.5%, which is better than a credit card, right? Instead of paying Amex 20%, you’re paying yourself back 3.5%.

You get tax-free, penalty-free use of the money, and you’re also growing at a 3.5% clip. Not great, not horrible, but you get the money versus taking a taxable distribution, paying tax and 10% penalty, or dealing with credit card deficits and paying very high interest rates to the credit card companies.

So it’s a tough situation for a lot of us. Inflation is real, as I mentioned, highest inflation period since 1982, which I don’t even remember. And it could get even more expensive depending on what happens in Ukraine or what happens in the Middle East. If there’s an Iran deal, maybe Saudi Arabia, UAE don’t want to play ball with the US, and maybe they actually cut production and prices go up. There’s a lot of different variables, a lot of moving parts that can happen, and super malleable. So we have to be cautious and at least know what our options are. That if we have a situation where we’re in a bind for cash, there are tax efficient ways to grab that money using your retirement account, i.e. through the loan or the IRA 60-day rollover window. But remember, it can only be done once every twelve months.

If you have a self-employment activity, even if you have a full time job at Company XYZ, but you have a side gig and you sell stuff online; baseball cards, shoes, art, food, whatever it is, even if you’re only generating $500 a $1,000 a year. If you have other rollover funds from an IRA, you can roll it into that 401(k) tax-free, and then borrow 50% or $50,000, whatever is less, and then use that to cover some of these crazy price increases.

I was at a park a couple of weeks ago and I saw a banana and they wanted to charge me $3.50 for the banana. It was like a game, a kid’s game, but I couldn’t believe it. Right? So, this is the kind of world we’re in right now. Hopefully the prices subside, but we’ll see what happens in Congress. They want to fuel the economy with more money, so this may last a little bit longer. But be cautious and know what your options are. Vis a vis, your 401(k) or IRA.

So, thanks again for listening if you’re watching on YouTube. Really appreciate it. Don’t forget to subscribe; weekly podcast drops every Wednesday, so don’t forget to check me out next Wednesday. Have a great rest of your week and talk to everyone again soon. Be well.

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