In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses how you can use your retirement funds to help alleviate the cash flow squeeze you may be suffering from due to inflation.
Cash Flow Squeeze – Your IRA or 401(k) Can Help
Hey, everyone, welcome to another episode of Adam Talks. I’m Adam Bergman, tax attorney and founder of IRA Financial. And on today’s episode, going to be talking about how you could potentially use your IRA or 401(k) to help meet a cash flow squeeze. And in this period of inflation, classified as pretty high inflation, some of the highest in our lifetime, if you’re as young as me, I wouldn’t say young anymore, but if you’re my age, we haven’t really experienced inflation of this magnitude: 8%+. I talked about it on a previous podcast, the recent March numbers. And you don’t even need to trust the government. You could just go to a local grocery store, go to a restaurant.
I went to a restaurant that I’ve been going to for like 30 years and I talked to the maître d’, the guy who sits you, and he’s basically just like, yeah, we just added $8 to all our entrees. They’re getting squeezed. Everyone’s getting squeezed. Whether you’re flying, renting a car, just trying to get by day to day, we’re all dealing with cash flow squeezes.
So, I wanted to do a podcast to kind of talk about some of the ways you can use your IRA or 401(k) to meet some of these cash needs which, summer’s coming, we’re going to do some traveling. Gas prices are like out of control. We know what’s going on with Ukraine, Russia. Will that get better, quickly? We don’t know. Not sure how that will develop, how that will impact the price of fuel, but with summer traveling, I don’t see it getting cheaper and who knows what’s in store. So, I don’t think we’re going to be seeing a lower rate of inflation.
And one other area that people aren’t really talking about is China. Shanghai, which is a city of 26 million people, almost as many people as Texas, they’re in lock-down. So, that’s going to have a real, real major impact on supply chain, which will then cause issues in terms of supplying goods to us Americans to consume, which will mean higher prices. So I think inflation will even go higher.
So, what can we do? We have IRAs, 401(k)s. There’s 60 million people with IRAs, $13 trillion. There’s $33 trillion in retirement money, including pensions, 401(k)s. If you have access to your money, which we’ll talk about first, who has access to their money? And then what are some solutions that we could potentially all use to meet certain cash flow?
So, let’s talk about IRAs and 401(k)s. IRAs, 60 million IRAs, about $13 trillion, maybe a little less the way the market has been performing in 2022. But you’re talking about a situation where a lot of us have IRAs. And when you look at IRAs, anyone can tap into their IRA. There’s no triggering events like there are for 401(k)s, which we’ll talk about in a second. So that means you can touch your IRA. The issue is if you touch it, and you’re under 59 1/2, you may get slapped with a penalty, 10% penalty, and tax on what you pull out. So, that’s all, obviously there, to impede you to take the money out. The IRS, government, when they built these rules, want to make you think twice before you take a distribution. For good reason, right? Leakage isn’t good. The more we all have in a retirement account, we all could benefit when it comes to saving, an IRA or 401(k) is the best, most tax efficient way because of the power of tax deferral, the power of compounding returns. Your money should double eight years, assuming an 8% rate of return, and the ability to get a deduction when you make a contribution in the pretax IRA world. So you can touch your IRA at any point. Just if you’re under 59 1/2, 10% and tax. We’ll talk about Roths a few minutes.
401(k)s: not so easy. If you are under 59 1/2, and you are currently employed, you don’t have access to your 401(k). You need what’s called a plan triggering event – which means you either leave your job, plan terminates, or you reach the age of 59 1/2. So, if you got a cash flow situation, you have a 401(k), you don’t have as much flexibility as with an IRA.
But, first option is a loan. If your 401(k) has a loan option, which many plans do, you have the ability to borrow the lesser of $50,000 or 50% of your account value and use that loan for any purpose, including paying off credit card debt, paying your rent, paying your mortgage, cash flow issues, you’ve got to pay for your kids to go away this summer. Whatever it is, you can use your plan to pay for it.
Now, the beauty of the loan is you get tax-free, penalty-free use of the money. You’re paying yourself back. The lowest interest rate you can charge, as of early May 2022 is 3.5%. Rates are going to go up; that means the interest rate on the loan will also go up. It’s a five year loan. It’s a straight loan, so it’s a mix of principal and interest; can’t do any balloon payments. You can pay the loan back quicker. There’s no early distribution penalty, but at least you get that use of the money.
So let’s say you have $40 grand in your plan; you need ten grand. You can borrow it, tax-free, penalty-free, pay off the debt, whatever, or use it for whatever you need to use it for, and then each quarter, each month, each pay period, you just pay back your plan at a minimum rate of 3.5%. So, what’s happening here? You get use of the money without tax or penalty, unlike an IRA, and you’re paying your plan back at 3 1/2%.
So, the plan wins: it gets a 3 1/2% return, which honestly, the way the S&P 500 is performing this year, that’s pretty good. The S&P 500, the Dow, is down for the year, so that 3 1/2% is not bad, and you get the use of the money, which is even better. So, that’s the first really good option if you got a cash flow squeeze and you’ve got access to a 401(k).
The second is something called the 60-day rollover. So, let’s talk about IRAs first. So you have an IRA and let’s say you got a cash flow squeeze, you probably don’t need the money more than 60 days. What you can do is take a distribution from your IRA or Roth, use those funds for any purpose, and then return them within 60 days, tax-free, penalty-free. So you got basically a short term 60-day loan of those funds. One caveat, you can only do that once every twelve months. So just be cautious, once every twelve months. You can’t be doing indirect rollovers every day. But, if you’re in a crunch, that’s 60 days, it’s two months. Just make sure that you send the money back, whether it’s check or wire before 60 days, because if you don’t, it’s going to be subject to tax and penalty (10% penalty). So if you’re over 59 1/2, just tax. But if you’re in a bind, it’s actually pretty good because, for a lot of people, 60 days is enough to get to the next, whether it’s a bonus or your deal’s closing, or whatever it is, if 60 days gives you the cushion you need to meet that cash flow squeeze, then hey, it’s a really good way to do it. You don’t have to deal with a loan, just put the money back. But, you can only do it once every twelve months. So just be cautious. Now, if you’re married, each spouse can do it once in a twelve month period.
The third is hardships. Okay, so for an IRA, there’s not that many hardships. There’s very few exceptions. You can do medical bills; if you have medical bills in excess of 10% of your AGI, then you can take a hardship. Hardships mean you can take the money out without the 10% penalty, but you still have to pay the tax, right? You can’t get around the tax, but you can still take the money without that 10% penalty. Also, if you got a permanent disability, God forbid, or you’re a first time home buyer and need up to $10k, that’s a hardship as well.
Another thing you can do is something called Substantial Equal Periodic Payments or SEPPs. That means you can take out the money for either until you reach 59 12/ or five years, and you have to take out a set amount over that period; you still have to pay tax on those funds, but you get around that 10% penalty. The problem with the SEPP is that you’re locked into the amount you can take. So, if you are part of the substantial equal periodic payment process, you can’t maneuver. You got to take a set amount each year; if you need more, there’s nothing you can do about it. So, you don’t have a lot of flexibility, but at least you get some cash.
Hardships are tough to meet in IRAs. I really see them for first time home buyers or medical above the 10% AGI. Those are the two most common.
Now, what about 401(k)s? So there’s actually some safe harbors on 401(k)s. The first hardship that you can satisfy is immediate, heavy financial need. Okay? So, it has to be immediate and heavy, and the employer has to make this call for you, and the amount is limited to what you are needed as a necessity. So, if you really need the $10k, and that’s what you’re telling your employer, you can’t take $30. Okay, what do you need to, so basically you got to go to your employer and talk to your employer about the fact that you have an immediate and heavy financial need, and they’re going to look at all the facts and circumstances. They’re going to look what you’re using the money for. If you’ve gonna buy a boat or a Porsche, that’s probably not going to work out for you. And, even if it’s reasonable foreseeable, it could be okay.
Basically, these are some factors to consider. The distribution cannot be greater than what you actually need. The employee basically have used all other resources, including loans, to cover the expense. And basically, you’re not allowed to make employee deferrals for at least six months from the hardship. So, they don’t want you just taking this money if you maybe need it, you really got to need it. And if you haven’t taken the loan, you got to take the loan first. And you can’t be making employee deferrals while you’re taking this hardship distribution because, hey, if you really need the money, then you probably shouldn’t be considering employee deferrals. But it’s up to the employer; I’ve had to deal with it a few times, it’s not fun. And generally you grant it right, because you don’t want to be that type of person. But as long as the employee doesn’t say, I want to buy myself something stupid like a boat or second home, you grant the hardship. The IRS doesn’t really audit this stuff. It’s not in their interests; you just want to make sure that the employee’s done everything they could have under a plan like the loan to satisfy this immediate, heavy hardship.
Now, the IRS also issued safe harbors several years ago, and this is like for medical care expenses, costs directly to principal residence, not including mortgages; so if you had a flood or something, God forbid. Tuition-related educational fees and board expenses for the next twelve months, payments necessary to prevent the eviction of the employee, funeral expenses for the employee or spouse, dependent, and certain expenses to repair damages on the principal residence.
So, that’s on top of the immediate and heavy financial need. Recently, they made it a little bit easier to get a hardship, but you really got to show something. Okay?
Another option, if you have a cash crunch, is if you have Roths, you can always take a Roth distribution of the amount you contributed. So let’s say over the last five years, every year you put in five grand, you have $25,000 of contribution, and now the $25,000 is worth $75,000. Okay? You could pull the $25,000 out, even if you’re under 59 1/2, and the Roth hasn’t been open for five years and use it for any purpose. But again, it’s out of the Roth. You can do a 60-day with that and put it back within 60 days, but once the 60 day passes, it’s no longer Roth. You use the funds. That’s cool. You’re not subject to tax or 10% penalty on them because of the amount contributed. But they’re done. They’re not part of the Roth anymore. So, you got to be cautious because Roth is like gold. So, you really need to need the money or you essentially are out of any other options.
And the other is something I’ve seen done, and if your friend or your neighbor has expressed an interest to help you out and they have an IRA, they can lend you the money through an IRA. So let’s say they don’t want to tap into their personal savings, but they got an IRA in there with $20, $30, $40 grand plus, and you need $20. You could say, listen, buddy, lend me the money, I’ll pay you whatever, 4-5%, whatever the interest is, and it’s a good investment for your IRA and you’re doing a good thing. I’ve got a bunch of clients, not a lot, but I’ve got a bunch of clients do this. It’s a good way to feel like you’re helping someone. I’ve seen people do it in times of flooding. I remember 2012, there was major flooding in New York, New Jersey area, and I saw clients do it there. I had some clients in Louisiana recently. Last year, it was a hurricane and there were some major damages to certain communities, certain parishes, and some clients say, hey, I got a neighbor, a good guy, love the family, and they need a little money. I got this extra money in the IRA. I’ll charge them like a minimal interest. You should charge interest because you don’t want it to be deemed a gift, but you don’t have to charge them crazy amounts. Just something that’s fair. I would say over prime, 3.5-4%. Your IRA wins, they win, everyone’s happy, and it’s a good deed. It shows a lot of good character and also pretty good investment for your IRA. So, can’t be a lineal descendant; you can’t lend to a parent, child, spouse, daughter in law, son in law, or any entities controlled by such persons. But it could be a friend, brother, sister, aunt, uncle, cousin, nephew, second cousin, someone you go to church with, someone you play baseball with, whoever, right? So, it gives you some options and I’ve seen it work. And in this case, it works for both parties because the IRA is getting a good return. And again in 2022, 3.5%, 4%, it’s not bad. Not bad at all. And, your buddy gets to benefit as well because they need the money and they’re going to get it. So I’ve seen people do it to help a friend buy a first home. I’ve seen it to help friends, family get out of jams. So another option you can use, if you have a cash flow issue and you have a friend or a family member, nonlineal, that’s expressed interest to help you, it may be a little bit easier for them to do it out of an IRA than with personal money.
So there you go. I hope, first of all, none of you are in a cash flow squeeze. But if you are or you know someone is, friend, family, and they have a retirement account, they have options, right? They can do the loan, there’s a 60 day, there’s the hardship in the IRA and the 401(k) world. And also, if you have Roth contributions, you can pull those out without tax, just the contribution, not the earnings. The earnings, you need to be over 59 1/2 and the Roth has to be open at least five years. Or you can do some type of IRA loan or personal loan. But if they have an IRA, sometimes it’s easier for people to take their IRA and lend it because the money, they’re not going to touch for many years, and they want to have more control over their personal funds.
The IRA is just sitting there; maybe it’s not doing anything; stock market’s down, cryptos are down and they’re like, you know what, I’ll help my friend out, my neighbor, I’ll get 3-4%, two, three-year loan, no brainer. Again, I’ve seen a lot of people do this. It seems to work out. It seems to be a really mutually beneficial solution.
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