In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses the most tax-efficient ways to use retirement funds to deal with rising costs due to inflation.

Use your IRA or 401(k) as your Bank

Hey, everyone, Adam Bergman here, tax attorney and founder of IRA Financial, and welcome to another episode of Adam Talks. On today’s episode, I’m going to talk about the most tax-efficient ways that you can use your IRA or 401(k) to pull money out and use it to pay for higher, higher, higher, higher prices. Right? Inflation – 9.1%, 9.4%. Done a bunch of videos and podcasts on this topic. Unfortunately, it’s been a long time since we’ve had to deal with the threat of inflation. Not since the 80s, and I don’t really remember the 80s that well, at least the early 80s. Do remember the late 80s; not the early 80s when interest rates were 17-18%. So, we’re certainly not at that point yet, but the Fed has recently indicated that they’re going to raise interest rates another 75 basis points in the next month or so, and rates will probably continue to go up until the Fed feels like they have control over inflation. Fed’s been clear and pointed and stated they rather deal with a recession than runaway inflation.

So, I’ve gotten lots, lots and lots of calls and emails over the last months, but especially the last couple weeks, honestly, saying Adam, it’s tight. I got money in the markets down 30, 20, 30, 40%. Money in cryptos is down. My job, so far so good, that thankfully unemployment is low. But I’m cautious, right? I’m not doing great. I spoke to a mortgage broker yesterday. It’s dead. I spoke to a bunch of real estate agents. Adam, it’s dead. I don’t know how many homes are going to sell today. People are on the sidelines. The pricing is just too high and everyone is waiting for the drop. Plus, add in the fact that interest rates are so damn high and it’s awfully expensive to get a mortgage now. People aren’t buying homes.

So, there’s potential turmoil and people are just not doing great. There’s tightness in people’s financial feel-good mindset. So, had questions – how do I get into my IRA or 401(k), if I need it? I may not need it now, but if I need it, what’s the best ways to do it? So, I said, you know what, I’ve done some stuff on this, but let me do an Adam Talks on this. I got a really big audience, this podcast, and well, obviously, thanks to all of you, I’ve been doing this almost at 350 episodes, so it’s been a while and I love it, and it’s a great platform to just hopefully educating people about the power of the retirement system, the opportunity to invest in alternatives, and also some current events, plus updates in the law, which I enjoy doing.

So, let’s start with the IRA. You got an IRA, things are tough. What do you do? So, obviously the first thing you can do is take a taxable distribution, right? If you’re under 59 and a half, it’s tax and a 10% penalty. Not ideal, okay? Not ideal. You can do a hardship distribution if you can show that you have real financial hardship. If you can satisfy a hardship distribution, what you’re able to do is you’re able to pull the money out without 10% penalty, okay? So you can still pull it out, you still have to pay tax on it, but you get around the 10% early distribution penalty. Okay, so good; better than paying tax and a 10% penalty, but obviously not as good as tax free, okay? So, that’s something to remember. And you generally have to show hardship, right? There’s got to be economic hardship, immediate and heavy financial need, for 401(k)s, and we’ll get to that in a minute, there’s some safe harbor rules, IRAs, medical and other financial needs. And you’d have to talk to your financial advisor, or Self-Directed IRA custodian, and they’ll assist you with that and making sure that you satisfy that hardship.

In the Roth IRA world, if you have made contributions to a Roth IRA, you could pull those out tax-free anytime. So let’s say in 2012 to 2018, you put in $5,000 a year. So you have $30,000 of contributions. And now the $30,000 is worth $100,000. Okay? The $30,000 you can pull out anytime you want, tax-free, penalty-free. The $70,000 of growth on that $30, that you need to wait till 59 and a half and the Roth has been open at least five years to pull that money out tax free. So, contributions to Roths can be pulled out. Conversions to Roth, you technically have to wait you’re over 59 and a half to pull out, but contributions you can pull out. So, if you are in a financial despair, if you take a traditional IRA distribution: tax, 10% penalty, if you’re under 59 and a half; hardship, just tax; over 59 and a half, just tax. A Roth IRA – contributions can be taken out tax-free at any point. If you are under 59 and a half and the Roth’s been open less than five years, it’s and not an or, it’s tax and a 10% penalty on the earnings. Okay? So, if you have little contributions but a lot of earnings; if you did well and whatever investment you did, you really want to wait till you’re 59 and a half and the Roth’s been open at least five years. Roths are gold right? In God we Trust In Roth we Prosper. That’s a book I wrote. So, you really want to be patient and not tap into that Roth as long as you can. It’s better to tap in potentially, maybe hit the contributions, maybe you go the IRA and a hardship, but really try not to touch the Roth because of the immense value of tax-free growth.

Now, there’s also something called substantial equal periodic payments, where you can do it with an IRA, where you can set up, where you can take out a little bit each year up to your the lesser of 59 and a half or five years; so until you reach 59 and a half or five years, and you only can take out a set amount, and it’s a small amount that’s set by a formula/table that the IRS provides. So, you can’t just say, okay, I want $10,000 this year, or $2,000 next year. No, it’s a set amount, like 1-1.5%. It’s a small amount. So, sometimes a substantial equal periodic payment solution doesn’t really work, because if you need just a chunk of money today and it’s not steady throughout the next several years, it’s generally not a good solution. So, that’s the best way to tap into your IRA if you need money.

And by sense, the IRA can serve as a personal bank account, right? Because obviously it’s there. It’s growing without tax. That’s the power of the retirement system, the power of deferral. Your money grows tax-free, and every eight years, your money should double, assuming you could gain an 8% rate of return annually. That’s the power of compounded returns. That’s why the US. Retirement system is so attractive. Now, obviously, when you pull money out, you leak money out. And that’s not ideal, but hey, we all have to do things that we don’t want to do, right? Things could get rocky. We saw that in ’08-’09. I had lots of friends, colleagues at law firms that pulled some money out because things were a little shaky there. They were nervous. And that’s okay. You just want to be smart about how to do it and be tax efficient. Don’t just run and take a taxable distribution. Unfortunately, not all financial advisers are not tax lawyers. They don’t understand the tax code.

Yes, retirement accounts are products, right? You can buy socks and ETFs and mutual funds, real estate, but it’s based off the tax code. IRAs are found in section 408. It’s a tax provision. So, you should work with an accountant, tax professional, help you navigate the rules, and hopefully this podcast will help you figure out the most tax efficient way to pull money out of an IRA.

Let’s move to the 401(k) world. So, obviously you need a 401(k). What’s the 401(k)? It’s an employer plan; it’s established by the business. So how do you get out, tap money, use your 401(k) as a personal bank account? Well, number one, 401(k)s are a little bit different than IRAs.  401(k)s, you can’t just pull money out anytime you want. With a 401(k), you need what’s called a triggering event. Generally, you need to be over the age of 59 and a half or leave your job, okay? So, if you’re 46 years old and you work at company XYZ and you want to pull money out, you can’t just take a distribution, even if you’re willing to pay the tax and 10% penalty, like you could in an IRA.

So that’s one of the main distinctions between an IRA and a 401(k), is the ability to take taxable distributions. So, how do you tap into your 401(k) if you need to. Number one, there’s a loan option, and this is probably the best option. IRAs do not have a loan option, whether it’s a traditional or Roth, a SEP, a SIMPLE; you cannot borrow a dollar from an IRA. I wish that would change, but the rules are the rules and the 401(k) loan is found under section 72 and it’s one of the most popular exemptions to the prohibited transaction rules under 4975(c).

So, (d)(1) is the loan exemption that allows you to borrow the lesser of $50,000 or 50% of your account value and use it for any purpose. You can use it for your business, personal expenses, pay off your mortgage, rent, medical bills, go on vacation, buy yourself a car or whatever you want. You can use it for. The only rules is, obviously, the loan option needs to be available on your plan. So you got to ask your plan administrator if you have a Solo 401(k) with IRA Financial, it will be automatically included. So you’re all good.

It’s a five year loan. If you want to use it to buy primary residence, you could increase that duration to 15 or 30 years, and the minimum interest rate is Prime, as per the Wall Street Journal, which is now 4.75 as of end of July 2022; that will go up, but as interest rates go up, the prime interest rate will go up as well, okay? So, that’s going to happen. So, if you want to tap in, this is a good chance because a lower interest rate means less money that you pay back your plan. So, the nice thing about the Solo 401(k) plan loan or the 401(k) plan, if you work at a big business, is you get tax-free, penalty-free use of the money. So, if you have $100K, you can borrow $50. If you have $40K, you can borrow $20. If you have $800K, you can only borrow $50. You can use it for any purpose and you got five years to pay it back. You got to pay back at least quarterly, but you can pay back weekly or biweekly or monthly and you’re paying yourself back. That’s the best part of all this. You are paying yourself back. So, instead of paying a bank or a credit card or a payday loan-type company that’s charging you egregious interest rates, you’re paying yourself back at a 4.75 rate of return, whatever the interest rate is. You can actually even use a higher interest rate if you wish. Why would you do that? Well, you can push back more money into your plan, right? If you use a 7% or 9% interest rate, you’re going to have $50K loan, for example, plus the interest on that loan. So, you’re paying yourself back. In fact, the plan is getting a really healthy rate of return. Maybe it’s 5%, 6%, 4.75% on the money and you’re using the money tax-free, penalty-free for any purpose.

The downside is obviously you’re capped at the $50,000 or 50% of your account value. Also the downside is leakage. Unfortunately, not everyone can pay back the loan. So, you want to be able to just take enough that you need. Now, depending on your plan documents and why I say depending, is not every plan is the same. The Solo plan you get at IRA Financial will be different than a plan you get at Schwab. Our plan is open architecture and includes all available IRS options. We even allow you to do multiple loans at a time. You can’t surpass the 50,000 or 50% account value limit, but you can do multiple loans; up to ten. So, let’s say you want to borrow $5,000 this year or maybe in six months you want to borrow another twelve or eight months later you want to borrow another three. You can do that. And how does that help? Because it will kind of shorten and lower your interest rate payments and allow you to hopefully have better cash flow and make sure you pay back the loan.

If you fail to pay back the loan, you’re going to pay tax and potentially a 10% penalty on the outstanding amount if you’re under 59 and a half and just tax on the outstanding amount if you’re over the age of 59 and a half.

So, the loan I think is the number one thing you should be looking at. Unfortunately, if you have an IRA you’d have to set up a Solo 401(k) to do the loan. And don’t laugh, I would say in 2009, 2010, 2011, I probably set up hundreds of plans where people just set it up for the loan. They said yeah, maybe I’ll put contributions down the road, but right now I need the $50k. I have an IRA, I have a SEP IRA. I can’t borrow a penny from that; I need to do the loan. Adam set my business up with a Solo K. I’ll roll the $100K tax-free from the SEP to the Solo K. Bang! Borrow the $50K, use it for whatever I need, pay back the plan, win-win. So, that to me is the best option.

What happens if you don’t have a loan feature or you already used the loan, you need more money? So, if you’re under 59 and a half, the next thing you can do is a hardship, right? The IRS was put more safe harbors in 2019 that basically says you just got to prove that you have immediate heavy financial need or medical conditions or you need to pay or repay a loan; certain requirements in the regulations that will allow it, such as educational costs, payments to prevent eviction, funeral expenses, certain expenses to repair damage on a residence, medical care, costs directly related to a principal residence, excluding the mortgage; like your roof is damaged and you need the money to fix it or you’re going to go under, things like that. So, you can do that. You still have to pay the tax. Remember, not the 10% penalty, but you can do the tax, but you got to satisfy that specific category of hardship. Okay? So not everyone can do that. If, let’s say you just need a little bit of money, you may not satisfy the hardship. Although, the safe harbor rules have made it easier and new laws are proposed and it should be passed this year as part of the SECURE Act and very relevant legislation that is connected to it that will make safe harbor and make hardship distributions easier to acquire. And basically just say you have to self-certify. So, you have to go through the company still, but they don’t have to check your bank account and tax returns and look at your medical bills to confirm that you need it. You’ll basically just self-certify it and then I guess the IRS can audit you, but it’s just going to make things easier. So, that’s good. But again, once the money is out, it’s out, it’s a distribution. It’s not the loan where you’re paying yourself back, or paying the plan back, it’s gone. Okay? So you got to be super careful. You get around the 10% penalty, but you unfortunately can’t do the; you still have to pay the tax on it.

One other thing I forgot to mention in the IRA world, which could also apply to 401(k)s, is the 60-day. In an IRA, you have, once every twelve months, not a calendar year, once every twelve months, you could pull money out of your IRA, any amount, and use it, but you got to return it within 60 days. You can only do that once every twelve months and you can use it for any purpose; you need to return it in 60 days. If you take cash out, you got to return cash. If you take property, you got to return property. So, you fail to do so, you’ll be subject to tax and potentially a 10% penalty if you’re under the age of 59 and a half.

Now in a 401(k), you’re not going to be able to do that unless you’re over 59 and a half because you’re not going to have that triggering event to do the 60 day. So, if you’re over 59 and a half and you have a 401(k), you can technically do the 60 day-er if your plan allows for it, but you got to return those funds in 60 days. Okay?

So, just in sum, the IRA is easier to pull money than a 401(k) because you don’t need a trigger event, but there’s no loan feature. So, you’re really dealing with distributions, whether it’s tax and a 10% penalty if you’re under 59 and a half, whether it’s just tax if it’s a hardship, whether it’s a 60-day, you’re limited to that 60-day period, or whether it’s a Roth and you can get the contributions out tax free, but the earnings are still subject to that tax, that 59 and a half and five year rule.

Moving on to the 401(k) world, remember, you got to satisfy the plan triggering event. You got to be over the age of 59 and a half or leave your job if you want to tap into the money. The loan, the loan, the loan is key. You’re paying yourself back, you get tax-free use of the money; penalty-free use, five year, you can pay quarterly back, interest rates go back to your plan. So, it’s a win-win. You get to use the money and your plan grows. That to me is your best solution. They haven’t increased the loan limit in many years, at least 25 to 30 years, and I’m not sure they’re going to raise it because the IRS isn’t very keen on the loans. Why? They think people abuse it and they don’t pay the loan back. And then there’s leakage, right? If you had $100K in your 401(k), you borrow $50 and you fail to pay back $40, you got $60 left. And the IRS is actually on our side; they actually want us to save and have a lot of money when we retire for probably selfish reasons. They want probably to lower Social Security at some point. So, they want to make sure that we got enough money in our savings, although it’s a private retirement system, it’s not a public retirement system like a lot of European countries, so we are on our own and that is why I do these podcasts. The government will not be taking care of us when we’re older. They will give us some Social Security. Hopefully, that will stick around when I’m older, but there’s no guarantee. So, we need to take charge and take control of our future and education is the first step, right? We don’t learn about retirement accounts. I went to college, I went to law school. I have a Master’s in tax law. I practiced law for nine years in some of the largest law firms in the world. Not one course, not one set of information, not one book, not one email, nothing on how IRAs and 401(k)s work, okay? The only reason I got lucky, got in this business, is I helped a client of the law firm I worked at investigate using an IRA to buy a hedge fund. And guess what? I had no idea. And the partners I talked to, no idea. I literally thought that IRAs had to be invested like 401(k)s in stocks, mutual funds, ETFs. I had no idea. Blown away when I learned.

So, if I, someone with a law degree, not that I’m smarter than you, but I do have a law degree and I have a Master’s in tax law, if I have no idea about how the IRA and 401(k) rules work, how distribution rules work, contributions, triggering events, loan, alternative assets, if I had no idea and was never educated, how can all of you it’s? It’s not fair, right? You guys are focused on your job, your families, your profession, your careers. Can’t know everything, right? I’m a tax lawyer. If you ask me a litigation question, I would have no idea. I’ve never been to court in my life. If you ask me a securities question, I probably wouldn’t know much about it. If you ask me a question on real estate financing, probably wouldn’t be the best lawyer to talk to.

So, it’s very specialized, and this is a super specialized area. So hopefully, you’ve listened or you watched this podcast, and now you know the most tax efficient ways to use your IRA or 401(k) as a bank. And hopefully you don’t need to, right? This is just a hey, an in the case situation, but if you need it, the information is here for you, and you can now know the best, most tax-efficient ways to tap into your retirement account.

Otherwise, I hope you guys are enjoying your summer and thanks for spending some time with me today, and I look forward to chatting with all you again next Wednesday. Be well and take care.