The financial crisis has spawned the CARES Act, which changes the rules around getting money out of your retirement account. Jeff and Rachel discuss the new options for taking money out of your IRA or 401(k). The limits are higher, the taxes are lower, the penalties are waived, and you can even avoid paying taxes on the withdrawals altogether. Tune in for the details.
The financial crisis has spawned the CARES Act, which changes the rules around getting money out of your retirement account. Jeff and Rachel discuss the new options for taking money out of your IRA or 401(k). The limits are higher, the taxes are lower, the penalties are waived, and you can even avoid paying taxes on the withdrawals altogether. Tune in for the details.
Rachel (00:07):
It's time to take control of your money, your health, your time, and your life. I'm Rachel Nabers.
Jeff (00:14):
I'm Jeff Nabers.
Rachel (00:15):
Welcome to self-directed life.
Jeff (00:18):
Okay. So here we are in the middle of this Corona virus crisis and the financial crisis and the government has done a lot of things. One of the things that they've done is change the rules around getting money out of retirement accounts without penalty. Just on a high level, Rachel, what is possible now with an IRA and a solo 401k that was not possible a month ago.
Rachel (00:49):
Sure. So what we're going to be talking about as a result of the cares act, which is the Corona virus aid relief and economic security act. And essentially what Congress did is pass a law that makes it easier for people to get money out of their retirement account in a time of economic hardship. So a lot of people keep a lot of money in their retirement accounts and when they are experiencing economic distress, they might need access to those funds.
Jeff (01:21):
Right. And so in normal times you can distribute money out of any retirement account and you're going to pay taxes on it as if it were earned income, kind of like a salary or any other earnings. And you're also then going to pay a 10% penalty if you're making that distribution before age 59 and a half. The caveat to that is if you have a Roth IRA and you're making qualified distributions, then that is tax free. So I guess what we're talking about here is you have money in a retirement account and normally when you distribute out of it, you have to pay taxes. Now we have a way around that. And then additionally, when you have a solo 401k, you can always borrow money out of it, like a line of credit or what they call a participant loan of up to $50,000. And you can pay that back over a period of up to five years. So let's start with the distributions. Let's say somebody has money in a traditional IRA, a traditional meaning the taxation, it could be a self directed IRA with traditional taxation.
Rachel (02:37):
And traditional taxation meaning that when you put money in, it's tax deductible, and you have to pay money when you take it out of the IRA, pre-tax funds.
Jeff (02:46):
Yeah. So what has changed about that? What happens now? If somebody is experiencing hardship right now and they distribute money out of their IRA.
Rachel (03:01):
So you're able to take out money from your IRA, first of all, without paying the early withdrawal penalty. So you save yourself that 10% early withdrawal penalty when you remove funds from the IRA. There's also an amount of funds that you can take out. You can take out up to a hundred thousand dollars from your IRA or your 401k and you have time to pay the money back. So there's a couple of of things that you can do. If you take the money out of the IRA, and you just say I'm doing this as a distribution, then you have three years to split up the tax payments that you would have made, which is a really big deal because the last thing that someone that's experiencing economic hardship wants to deal with is a huge tax bill.
Jeff (03:48):
Okay. So in that example, let's say somebody distributes 100,000 and they're under 59 and a half, first of all, they're not going to be penalized for doing it, being under 59 and a half, and secondly, let's just assume an effective tax rate of 20%--that $100,000 distribution would normally cause a $20,000 tax hit that they would have to pay that year.
Rachel (04:15):
Right.
Jeff (04:15):
What you're saying now is, assuming tax brackets don't change and it's just a 20% effective tax rate, that $20,000 could basically be.
Rachel (04:25):
like six and a half thousand a year.
Jeff (04:26):
Yeah, six and a half thousand this year, which would be next April 15th. And then again the third, the second, and then again the third. So you can withdraw and you can spread the tax bill out by three years and eliminate the 10% penalty. Now is that only during the year of 2020?
Rachel (04:49):
Yes.
Jeff (04:49):
Okay.
Rachel (04:49):
So you have to take the distribution before December 31st, 2020. So this is a, if you don't do it this year, it's gone kind of a thing. Now the IRS and the department of labor can extend things at any time. But for right now, if you're experiencing this economic hardship, then you do have this hard deadline of December 31st.
Jeff (05:10):
Okay. So what needs to be done to document the hardship to be able to take advantage of, and by the way, guys, this is, we're just talking about different things to be done. We're going to talk about what maybe makes the most sense. This first one we're talking about probably doesn't, in my opinion. We'll cover that later. But let's say you want to make a distribution. You want to spread the taxes out over three years. You know, one person may be having a hardship and other doesn't. What's the documentation or the requirement to say I'm having a hardship?
Rachel (05:40):
Sure and before we get into this even further, we definitely need to just give a disclaimer. You know, we're just doing a podcast here. If you have questions about your specific tax situation, because this is going to affect everyone differently, then you need to make sure that you're working with your CPA. So you have to self-certify. And I'm now specifically talking about self-directed retirement plans--a self directed IRA, a solo 401k--the cares act is able to be applied to regular corporate 401k plans. So if you're out there listening and you're wondering if your workplace,
Jeff (06:16):
Hang on, you're not talking specifically about self-directed.
Rachel (06:18):
I'm going to come back to it in a second, I'm just sort of, I want to go up a level first. So if you are wondering if your workplace 401k has adopted the cares act and its amendments, the answer is maybe. Some of them haven't. So if you're just out there and you have a regular workplace 401k and you want to go and take this economic hardship distribution, it might not be possible at every 401k plan--not all have adopted it.
Jeff (06:45):
So we can chalk that up to yet another reason why you should be self-directing your retirement plans, because you don't have to wait for some bureaucratic body to catch up to the law. In fact, that's kind of funny because the pension protection act was passed in 2006, and that's what made it so that, theoretically, you should be able to move any money from any defined contribution retirement fund to any other one. And yet, today, in 2020, not all corporate 401ks even allow for that. Okay.
Rachel (07:17):
Well, I want to bring this up, you know, because we've had clients who specifically have come to us and said, look I need access to these funds. I want to start a self-directed IRA or a solo 401k with Nabers Group, but my employer is telling me I can't take the distribution. So it's really important to know if it's available to you in your own workplace. Maybe encourage HR to to look into it because I think it's something important for the American people.
Jeff (07:42):
Right. And now is a good time to, if your current employer's 401k allows you to transfer money out while you're still working there, you should take advantage of that and move that money over to a self directed IRA or 401k where you'll never have some board or HR department or administrators standing between you and the money that is yours.
Rachel (08:09):
Right, because that's what we're seeing is happening right now. People need the funds and they're not able to get them. So let's just sort of transition to how do you qualify, how are you allowed to take this because.
Jeff (08:19):
You basically write a letter saying I have an economic hardship and hereby certify.
Rachel (08:24):
You do. And if you work with an IRS approved plan document provider, like Nabers Group, then we have these self-certification forms for you that you can complete. And you're basically, you know, certifying to yourself as your plan administrator, or maybe to your IRA custodian, that you've experienced adverse financial consequences due to Corona virus. Either you were quarantined, or you're furloughed, or you're laid off, or you're experiencing a reduction in work hours or you're unable to work as much because of a lack of childcare, or the business that you own or operate is closed or is operating under reduced hours, or you have the virus or someone in your family has the virus. It's pretty widespread, but it still needs to be legitimate. I mean, I think these days it's pretty easy to justify that everyone's being affected economically, adversely by the Corona virus. But we'll get into a bit more nuances of how you want to be responsible with this distribution.
Jeff (09:23):
Yeah, I mean, I was just thinking about that. You know, somebody, everyone is affected so there's nobody who couldn't self-certify and have it be the truth. But if you distribute $100,000 and buy a new motorcycle, then.
Rachel (09:36):
Exactly.
Jeff (09:38):
You know, a lot of people will go, then they're going to come in and audit you and get you. Maybe, but you're just stupid. You know, like the real reason why you shouldn't take your retirement funds and go buy a motorcycle. right now is because you're robbing your future self. And if you're not financially free today, it's because your past self robbed you. So it's more, I think ultimately the element of self responsibility should be that North star. And in this case, it sounds to me like with what we know so far, anybody can write a letter and specify which one of those many things they have that applies to them. Okay. So we've got distribute and spread out the tax consequences. I'm particularly not a great fan of that because in a financial crisis is when the best investment opportunities are. Right? So the average person has it backwards. They're buying a rising stock market and that's it. You know, Warren Buffet famously, heading into this crisis, had the biggest cash position he's ever had ever. Now, part of it is, it's a good move. He's smart, he turned his risk knob down by getting more into cash. The other part of it is, boy, he needs that cash. He was invested in airlines. He basically sold after a big drop. He's invested heavily in banks, right? So Warren buffet may not go down in history as the world's greatest investor. He may go down in history as one of the people who had a good run during a period of time. But anyways, buy when there's blood on the streets, right? A lot of people will get kind of like confused about that. But you know, once you can establish that everything is safe, you're doing an important job and rebuilding the economy to buy distressed assets, because once they seem like a good buy to you, you're coming in and adding a little bit of buying pressure. And in the case of say like bankruptcies, bankruptcies are an important part of a financial crisis because somebody who has money and is a good steward of wealth can come in and buy these assets that are being transferred out of the hands of bad stewards of wealth. So all I'm saying is I don't like--I would say the least favorable option in this cares act is to go ahead and distribute because you're just taking money away from your future self and you're not taking advantage of taxes.
Rachel (12:09):
So there's an alternative to that, which is a temporary distribution, where you can take the money out and then as long as you put it back within three years, it's considered an eligible rollover distribution, which basically means no taxes.
Jeff (12:28):
That's great. So if I'm understanding this correctly--now we're getting into something that--and is that also $100,000 limit?
Rachel (12:34):
Yes.
Jeff (12:34):
Okay. So now we're getting to something that might make more sense.
Rachel (12:36):
And this actually is, this limit includes all amounts taken from all plans sponsored by the same employer. So that's an interesting sort of read between the lines thing as well because what it appears that it's saying is you could take a hundred K from this employer 401k, you could take a hundred K.
Jeff (12:54):
Per plan, right? Yeah. So, that's really great because, you know, for people who have a solo 401k, including those who have one with us, from solo 401k.com, you can always take up to a $50,000 loan at any time. But, with that, you have to pay a monthly or quarterly repayment over a period, a maximum of five years. So what that means is if you borrow $50,000 today, you're going to be paying about a thousand dollars a month starting next month. So this is kind of like being able to have that loan and the payment can, there can be no repayment, but at the very end of the three year period, you could just pay it all back, right? So that's interesting. Like if you wanted to start or grow a business or take advantage of some other profit opportunity that for any reason doesn't make sense to do inside the 401k--Like, for instance, start a business, right? So retirement plans are not really well set up to have a business operated from inside the 401k plan. It's not a real good idea generally to have your 401k own an operating business, but now you can take not 50,000 but 100,000 out, start or grow a business, pay no tax consequences on that, have no monthly or quarterly payment, and basically take advantage of the opportunity to the maximum, and then as long as you get the money put back in within three years, there's no tax consequences. And if what you did is generate a profit or hopefully even better, a stream of profit, then that stream of profit can continue to operate and the money goes right back into the 401k. And then on top of that, if that stream of profit is coming from a business that doesn't have W-2 employees other than yourself, you can then take up to $60-120,000 of that profit and not pay taxes on it and stick it right back into a solo 401k. So that's a double whammy in your favor.
Rachel (15:03):
Yeah, it definitely is. I think you just need to, you really need to consider your short, medium, and longterm strategy when you're doing this. So it sounds very sexy to just be able to take a hundred grand out of a 401k and have three years to pay it back. But what I think a lot of people don't realize is that three years goes by like that. And, if they don't have the money to pay it back in three years, then that is when you're going to get hit with that, you know, 20,000 in taxes or whatever.
Jeff (15:34):
Well, that's what I'm saying. Don't go buy $100,000 worth of boats, motorcycles, jet skis--go and put that money to work. Put that money to work in a way that makes money. The purpose of that money should be to make money to help you get through the hardship of what other, whatever other ways that you were making money that aren't going so well. So if you're in a business that was not recession proof, then that $100,000 highest and best use would be to start a business that is recession proof. So that's method number one, distribute the money, split the taxes over three years. Method number two, distribute the money. And you have a three year window instead of a 60 day window to just put the money back in there and avoid tax consequences. Any money, any positive fruits of the placing of that capital can persist, and you put the money back into the 401k or IRA. Another interesting thing is a participant loan is not available to IRAs. It's not available to corporate 401ks that the plan administrator hasn't provided for the participant loan. Guess what? Most don't. The participant loan is almost exclusively something that you can only do within a solo 401k. And thanks, thanks to this cares act, it is now--you know, it's not technically a participant loan, but basically borrowing up to $100,000 and paying it back within three years is available to anybody with any retirement account, as long as you don't have a corporate administrator standing in your way of using the cares act in that way. What else can you do?
Rachel (17:26):
So the third way to get money out is going to be specific to a 401k plan, which is expanded loan provisions for that participant loan.
Jeff (17:38):
Let's take a quick sponsor break and then we'll dive into that.
Rachel (17:41):
Sure.
Jeff (17:43):
By solo 401k.com solo 401k is a special retirement plan for entrepreneurs. Your solo 401k can unlock your retirement funds to invest directly in alternative investments such as real estate, precious metals, Bitcoin, private equities, private debt, startups, and more. You can combine alternative investments with tax deferred or tax free growth. You get the tax benefits of a normal IRA or 401k, but with access to alternative investments. Plus your tax deductible contributions can be up to $60,000 per year. You can even be your own bank and borrow up to $50,000 tax free to start or grow a business, pay off debt, buy equipment, gear, or toys, or for any reason--all this using solo 401k.com. To learn more about reducing your taxes, investing in alternatives, and being your own bank. To finance your dreams, visit solo 401k.com today. All right, great. Now the third way actually has to do with something like a solo 401k.
Rachel (18:49):
Yeah, so that is that there are expanded loan provisions for a solo 401k participant loan. This is where you're able to take a loan from the 401k to yourself. This is a personal loan. It's not a loan from your 401k to your business. It's a loan from your 401k to you personally. And the expanded loan provisions are that for loans that you are taking from the plan anywhere from March 27th, 2020 to September 23rd, if you are a qualified participant, you know, having this Corona virus related distribution qualification, if you are adversely effected economically, et cetera, et cetera. And if you are taking a new participant loan between March 27th, 2020 and September 23rd, 2020, the loan limits are increased. You can now take $100,000 or 100% of the vested balance, whichever is less, which is double what it normally is. Usually you can only take 50 grand or 50% of your account value as a participant loan. Now you can take $100,000.
Jeff (19:55):
Interesting. And going back to the temporary distribution, that's not limited to a percentage of your account balance, right?
Rachel (20:02):
It is not. It's up to a hundred thousand.
Jeff (20:03):
Okay, so right now if you have a solo 401k and you have $100,000 in it, you can do the normal participant loan, which is $50,000 and you pay it back monthly for up to five years. Or, under the cares act, if you do it between now and September 23rd, you could choose to have $100,000 and is it still like a normal participant loan up to five years?
Rachel (20:35):
So If you are a qualified participant under the corona virus distribution, then all of your loan payments due any time from March 27th through the end of the year are suspended for a period of one year. So that means you get an extra year where you don't have to pay the loan payments. However, the loan payments restart as of the first due date that occurs on or after January 1st, 202--I know this is sounding like legalese, but we'll come back to it in a second. And the skipped payments are adjusted to reflect interest during the suspension period. So that means you do have to pay a little bit extra interest for that skipped year of payments.
Jeff (21:16):
Yeah, good. You get to pay interest because paying interest on a participant loan is like another backdoor method of contributing money into the retirement plan that's going to get the tax benefits of growing without taxes. Okay. So that's great. And now, going back to my question, you can still do a five year loan--It just becomes essentially almost a six year loan because you can make a new participant loan right now and then pay the first payment in January of 2021. And then ultimately it becomes, you know, almost like a five and a half year loan and you end up, because you're deferring payments and accruing more interest, you end up paying more money back in, pay more interest back to your own future self and the 401k.
Rachel (22:12):
Yeah, that's correct.
Jeff (22:13):
Well that's great. So not only can you go to a higher limit of $100,000, instead of $50,000, you can go to a higher limit in terms of up to 100% of your plan. So like let's give another example. Let's say you had $80,000 in your solo 401k account. Well, under the normal provisions, your solo 401k loan could only be 40,000. And under this cares act, you could do a new one and it could be an $80,000 loan.
Rachel (22:43):
Yeah, you can take all of it out.
Jeff (22:45):
And by the way, you know, most people with a solo 401k also have their participant, or their spouse, participate in the solo 401k. And that means their spouse can have some sort of involvement in the sponsoring business and their spouse can then roll over money. And their spouse can then contribute from their compensation from that business. And that participant loan is on the participant level. So a solo 401k plan very often has a person as participant one and their spouse as participant number two and that means each of them have their own account and can have their own participant loans. So that's pretty exciting. Are those main three ways?
Rachel (23:34):
Those are the main three ways.
Jeff (23:35):
Okay. Awesome. So let's, let's think about this. One thing I want to point out too is with a solo 401k, your limits on participant loan are limited to any outstanding participant loans per plural. So if you have a participant loan right now, and let's say you have 200,000 in your solo 401k and you have a loan out right now with a balance of 10,000 then you could still borrow another 40,000 with an additional participant loan under the normal provisions or another 90,000 under the cares act.
Rachel (24:12):
Yeah, there's a rolling 12 month calculation with participant loans. So you would definitely need to talk to your CPA or look at your documents and see when you took out the loan and where you are in that rolling 12 month cycle. But yeah, that sounds right.
Jeff (24:26):
Yeah, definitely. Okay. anything you want to add for anybody? By the way, one thing is you can just go to solo 401k.com use the chat tool on the webpage, call a phone number on the website, and our support staff is there for any, you know, rubber meets the road questions or getting going, taking advantage of any of this. But most importantly here on the podcast, we really just want to get the information out, but we are available to help.
Rachel (24:51):
Yeah, and I just had a couple of questions that clients had sent in that I wanted to address. So the first was can I take $70,000 now and 30,000 a few months later in parts instead of all 100,000 at a time and still qualify for no taxes and no penalties? The answer is probably. We're still getting guidance from the IRS and the department of labor on an ongoing basis. Things are changing a lot. Even if these plans are going to be formally amended, those amendments aren't going to come out until January of 2022. It just takes the IRS and the department of labor a long time to write these amendments officially with their language. So the answer is probably. You probably can do two distributions as long as you're not exceeding that total $100,000 cap.
Jeff (25:43):
Okay. And I see we've got a question. If I take the distribution and put money back within three years, does that mean I don't pay any taxes on that distribution?
Rachel (25:52):
Yes, that's correct. No taxes as long as you put the money back.
Jeff (25:56):
Awesome. now another one that came in is what if I just take the distribution and don't plan to pay the funds back? When do I have to start paying taxes on that distribution?
Rachel (26:06):
So you can start paying taxes as soon as you want, but you have to pay the taxes within the three year time period. So if you are planning on taking the distribution, just straight up taking the money out, you know, you're not going to put it back, breaking up your tax payments over three years will lessen that burden on you financially.
Jeff (26:27):
But you don't have to do that.
Rachel (26:29):
But you don't have to.
Jeff (26:29):
If you, if you're going, okay look, this could bump me up to another tax bracket, there could be some bad consequences. But if, if earlier money is more valuable to me than later money because of my hardship circumstances, then I can take a distribution now. And if I wanted to, even though it won't minimize my taxes, I could just pay all the taxes on it, literally with my 2022 tax returns.
Rachel (26:58):
Yes, that's true. And there's also going to be some people that it will make sense for them to take the distribution now, know, that they're not going to pay the funds back and pay the taxes now because then they can be done with it. They don't have to worry about it if their future is very uncertain.
Jeff (27:15):
Yes. But to be clear, you can take a distribution now and pay the taxes with your 2023 tax return.
Rachel (27:23):
Yes, correct.
Jeff (27:24):
Great. Now someone asked if I take the distribution, can I use those funds for any purpose? Like could I go buy a rental property?
Rachel (27:31):
Yeah, you can. Technically that's certainly a possibility. The only thing I would really caution you for is, you know, once you take a distribution from a 401k plan or an IRA, that's your money. So you can do whatever you want with it. Just know that we are in disaster relief times right now. That's the way the IRS is looking at this. They're giving you this hardship distribution as a method of disaster relief. So if you are certifying that you're experiencing economic hardship and you're having adverse financial consequences and then you turn around and use the money for something like an investment property I don't know, Jeff, do you think that that would be detrimental at all if the IRS is looking into it or something?
Jeff (28:16):
Yeah. Who knows? But honestly, look, if if you're in financial hardship and adding a stream of passive income to your life helps you, then that's kind of exactly what it's for. Right? Like if you were sitting there owning dividend paying stocks because that was like your financial plan, and then let's say you sold stocks hopefully before too much of the crash and then you went and placed that in good performing passive rental real estate, then you're number one, you're going to get more income than you got from those dividends. And then, you know, even if you sold after the dividend stocks crashed, then that just means you need a safer place to put that money anyways. Now the bigger issue is there's no need to take the distribution to buy a rental property. You can buy a rental property inside of your retirement account. That's what a self directed IRA and 401k is made for. So if you have a self directed IRA or 401k and you want to buy rental property, you can already do it. If you don't have a self directed IRA or 401k and you want to buy a rental property, you can just transfer that money into a self directed IRA as an alternative to what would become a taxable distribution.
Rachel (29:32):
So one of our clients I was speaking with earlier today, they were sharing that they own a personal investment rental property with personal funds, non-retirement funds. And they're considering taking this distribution so they can refi the loan and have a lower payment on their personally owned rental property. What would you think about something like that?
Jeff (29:52):
Sure. I mean, look, the people at the IRS are gonna go around and they're going to try to find people who are breaking the rules and they're even private companies that are almost like bounty hunters for the government that go out and try to find people who are misusing these SBA loans and things like that. But if you're not lying-- look, paying down debt, refi-ing it, anything that you think is going to help you, it's not up to the IRS or tax court to determine what is or isn't good for you in terms of what to do with your money. I think the question comes in, if your way of dealing with a financial hardship is to buy a jet ski, then that could get you into some trouble, right? But if it's to reduce your debt, yeah. That can help you through a hardship. If it's to increase your passive income, yeah, that could help you through a hardship. I think the question here is a lot of things that people would do with a taxable distribution from a retirement account, they don't realize they can do within a self directed retirement account. So that's why I think you know, talking to some experts, getting some guidance, and we're actually hiring right now, so we're dealing with a higher influx of people. If people hear our podcast or they see our YouTube channel and then they reach out for help on their individual circumstances, and we're actually quite busy right now in the middle of this crisis because people are starting to see the importance of getting good expert help from people who have a good handle on what's going on right now. Next question is, I have $98,000 in my account now and plan to add more today. Is there a minimum amount I need to have in my solo 401k after a hundred thousand dollar withdrawal?
Rachel (31:48):
No. When you have a solo 401k with Nabers Group, we don't have any minimum required for you to keep in your solo 401k plan. So if you need to take the entire distribution, you can.
Jeff (32:01):
What forms do I need to fill out to take a CVRD--Corona virus retirement distribution?
Rachel (32:07):
Or Coronavirus related distribution.
Jeff (32:08):
Related, ok.
Rachel (32:08):
So again, if you're a solo 401k.com client with Nabers Group, we have a self-certification form for you.
Jeff (32:18):
Okay. My business I run had hit hardships, revenues dipped significantly. Is that sufficient qualification?
Rachel (32:25):
I'd say probably yes. I mean, as we mentioned at the top of the episode, you're going to be really hard pressed to find anyone who's not adversely affected economically from the Corona virus. So yes, I think that would qualify.
Jeff (32:39):
Great. Can I take 70,000 now? You already answered that one earlier.
Rachel (32:43):
Yeah.
Jeff (32:43):
Okay, cool. So that's the pre-submitted questions. Thanks so much for listening to this podcast. It's new. We're finding our groove. We really are all ears right now for your feedback. In fact, we have a new digital ear. If you go to self-directed life.com you can click in the top menu to leave us a message and it's just a little thing you can click on your computer or your phone and you can leave us a message and if you have a question that you want to be featured on the show, leave that message there. If you just have some feedback that you want us to hear about what types of episodes you want to hear more of, let us know there. So thanks for listening and make sure you go to self-directed life.com to subscribe.