My 401k withdraw of funds scenario

My 401k pre-tax benefits:

With some exceptions, many in the personal finance space provide clear advice regarding 401k retirement savings. The key is to invest early, invest often in low cost index funds with a long term view that also will benefit from dollar cost averaging. Most importantly, never take out a 401k loan, as you will have to re-pay the loan using post tax funds from your paycheck; the money you are borrowing was withdrawn from your check pre-tax funds. Additionally, the time value of pre-tax 401k growth will typically be greater than the current value of that money today. 


Don't touch the sacred cow:

The message is clear, your 401k is a sacred cow, so don't touch it. Especially, and most importantly don't take out 401k funds and pay penalties based on your young age- This is exactly what I did over twenty years ago when I withdrew 100% of my company 401k, but the results were positive for me. At the time, the 401k service company didn't offer 401k loans for the type of investment I was heading into. 


LIttle Known/understood IRS exclusion:

Note that you can take your 401k funds from your employer sponsored plan without penalties at age 55 if you separate from your employer, beyond that you will need to be the standard retirement age, which I believe is 59. 

Read about the exception to the standard age 59 and half age exception clause titled the "55 year rule." 


https://www.irs.gov/taxtopics/tc558


From the IRS website:

"The following additional exceptions apply only to distributions from a qualified retirement plan other than an IRA: Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55..."


Real Estate opportunity:

So my situation was this, many years ago I had a real estate investment opportunity that required a significant amount of capital relative to my annual income. I had some funds saved away in my post-tax account, but in order to meet the conditions of this real estate deal I needed to dip into the sacred cow, my employer sponsored 401k. This 401k fund was 100% invested in a developing market mutual fund that had significantly outperformed the market during the five years of my employment. Perhaps this was another reason I was comfortable pulling the trigger on this deal.


Taxes:

Withdrawing these 401k funds meant that I sold all of the positions, paid an immediate penalty, and paid additional taxes the following year. My total return was still really good, but the penalties 

and taxes were reminder of my potential stupidity if the real real estate deal went wrong. 


Proceeds:

Fortunately, the real estate deal provided a return that greatly exceeded the cost of the fee's and penalties, plus it created additional growth making the deal even better. I ran the numbers recently to remind myself that my risky 401k move was not only a good deal, but it was a great deal. The developing market fund peaked soon after I sold those positions to fund the real estate deal. Additionally, the ten year period that I held the real estate investment coincided with a huge upswing in the west coast real estate market. I call this basic dumb luck created with a high risk investment decision and good timing.


Should you take a 401k Loan:

I am probably the worst person to give advice on this topic, as I broke from the herd and did an extremely risky move when I was much younger with my 401k withdraw of funds. 

The advice today is generally no, but it depends: If your 401k loan is needed because of a lifestyle expansion purchase, such as a new SUV or vacation, then I would say no. 

I would also look at all other options before doing this. Paying high fee's and taxes when you don't have to is a terrible tax avoidance strategy.


A better option, 401k to Roth IRA conversion

If you are an active FIRE community member, then you probably already know that you can also convert your traditional IRA (taxable) or plan sponsored 401k (deductible) funds into Roth IRA using a Roth conversion ladder strategy. This strategy appears to be the one exception in the tax code that allows you to convert and receive distributions of your original 401k dollars without penalties at any age. Although, this strategy requires careful planning which includes a five year cycle for your Roth distributions. Still, this is another reason to leave your 401k money where it sits so you can convert your annual expenses later and limit or potentially eliminate your tax liability- this of course will depend on your living expenses during retirement.


If you do decide to move forward with a 401k loan, make sure you understand all the details and risks, such as, if you leave your employer how will you pay back the 401k loan balance after your exit- which is required when you separate from work (fired, quit, it's all the same).  



Financial Sombrero



Building Wealth Knowledge Every Day



Note that I am not a financial or legal professional, nor am I licensed to sell securities, or any other financial instruments. Given this statement, I strongly recommend that you consider this blog as entertainment value. Although, I sincerely hope that I can motivate you to learn to build your own financial knowledge and wealth.