Should I Cash Out My 401k or IRA Now?

401k egg silverspoonThis might be one of my most controversial disagreements with financial advisors.

GOOD!

I've cost financial advisors and financial planners lots of money with my advice and put it back into the pockets of the people I care about more.

Is that okay to do?

So when is it a good idea, and when is it a bad idea?

Disclaimer: I no longer have a securities license to tell YOU specifically what to do. And some examples I am using was done in coordination with the investment advisor on my team after knowing each client's situation.

 

Now that's out of the way, let me explain further when it can be bad. When you cash out of those investments, you will need to pay taxes (unless it's a Roth IRA). In addition to that, if you're not 59 1/2, you will likely pay a 10% penalty on top of it. I've even seen cases where someone also had to pay surrender fees because they were in an annuity contract too. So, in general, when is it a bad idea to cash it out and pay those fees and taxes?

BAD IDEA

  1. You're going to blow it on something that doesn't put you in a better financial situation.
  2. You cash it out without a plan for how you will use it.
  3. You're investing it into things you really don't understand or don't have any control over.

This tends to happen when someone isn't being guided by someone who sees the big picture. When in doubt, don't get out. It's better to leave it alone for a few months than to make a rash decision.

However, there are times when it can make sense to stick your tongue out at your financial advisor. Financial advisors don't want you cashing money out of investments that they receive a management fee on, even though most do little or nothing to help you get your returns. It's purely because they sold you a product. I believe that investments should ideally pay you today rather than hoping it pays you down the road (if you live that long to see the benefit).

GOOD IDEA

  1. You use that money in times of dire need, due to layoffs, slow economic times, and so forth that can help keep you out of bankruptcy.
  2. You use it to pay off loans that have high payment to balance ratios.
  3. You use it to invest in your business or investments that you have lots of knowledge and control over. Oftentimes, you can avoid paying taxes or get a tax write-off at the same time as having to pay the taxes, minimizing the cost.

Examples of Wise Use

Example #1 - A 62-year old chiropractic client I had a few years back, that lived in the mid-west, was barely scraping by month to month due to the slowdown in his business. He got into a "mental toilet bowl" as I call it, where he lost his passion and drive, and the profits (or lack thereof) showed. However, in his previous years, he had saved a lot of money in his IRA that was valued at $500,000. Like many of my clients, he had assets but lacked cash flow.

When I looked at his situation, I saw that thru refinancing and paying off certain loans, we could free up $50,000 a year with only $100,000! I told him that although he will have to pay taxes on this money, he is getting a guaranteed high rate of return on his money.

His reply sounded like a financial advisor - "Well, how will I retire?" I retorted, "What kind of mutual fund will guarantee paying you at least 30-35% per year cash on cash returns?" Still, he was worried. Finally, his wife verbally slapped some sense into him and he understood (It's usually the wives who see the big picture first). As a result, he not only freed up the cash, but his practice started growing again because he didn't stay stuck in a scarcity mindset.

Example #2 - I had another client that wanted to know how he can have enough to pay for his son's college over the next 6 years. He had saved $50,000 in a 529 college savings plan. When we projected the numbers, he was hoping to have $70,000 by that point, which didn't bring him much hope. In conversation, he mentioned to me how he had a part of his business down to a science where he would spend between $30,000 and $35,000 to start a new office, and in 2 or 3 years, sell it to another owner for around $250,000. My team and I had him consider what would happen if he cashed out his son's college savings plan to start a new office. By the time his son would go to college, he could easily have started and sold 2 offices, grossing him about $500,000!!!


It's important to remind you that each of these types of "investments" that my clients made were well thought out and low risk for them. They were taking higher risks being at the mercy of the markets having no control to improve their present or future circumstances.

If someone can be a good steward with their money, all kinds of things are possible. Sometimes, people use their retirement accounts to pay for my services, for a business consultant, or for a new business venture. If they are willing to commit to making it successful, it's hard NOT to beat the returns of some crappy mutual fund. Nearly all of my clients get a return on their investment within 12-24 months, some within a few months.

So should you cash out your IRA or 401k? I can't tell you that for certain not knowing who you are as the "investor." The key is to be honest with yourself and ask whether putting that money to a different use will be a better expression of your stewardship.

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