No one in their right mind would recommend that you cash out your 401k before age 65. You’d incur many penalties and fees, and you’d miss out on the huge advantages of tax free investment growth.
I wouldn’t recommend it for anyone either. However, last Summer that’s exactly what we did.
We used the proceeds to invest in real estate. Why would we do such a reckless thing?
We understood the implications
We understood the rules around liquidating a 401k. I used to be a financial planner, so I understood the penalties and process for pulling money out of a 401k.
Early distributions are taxed at your ordinary income rate. There is also an additional 10% penalty on early distributions.
I knew our annual income would be much lower this year. My wife had left her job at the end of 2016. We were about a third of the way through 2017 with no trading gains for the year.
In the previous six years, It was very rare for me to have a losing month. I’d never had two losing months in a row. I knew I was on the way out.
I anticipated our overall income would be pretty low for this year.
I was right. Our tax rate in 2017 will be the lowest in years. So the tax rate on this 401k distribution will be minimized.
The IRS will send me a scary letter telling us we owe them money.
I’m not afraid of the IRS. I respect them, but I’m not afraid anymore.
I’ve received letters from the IRS over the years, auditing specific parts of my return. These letters usually assert that I owe them money.
Often times, they just need clarification. Referencing a specific part of the tax code will satisfy their questions.
This is another thing I wouldn’t recommend for others. You should hire a professional.
We saw an opportunity
Our goal in trading was to make it a business. This was hard and getting harder. No one “needs” stocks.
Real estate has characteristics that make it more businesslike. Everyone needs a roof over their head. Real estate investing is clearly a business with huge customer demand.
Real estate has a lot of tax advantages. Real estate investors can write off hundreds of business expenses. They can also write off interest, and hypothetical depreciation on buildings. Many successful investors pay little to no income taxes.
A lot of our penalty was paid out of “matching contributions”
The matching contributions we had received over the years felt like “free” money. It more than covered the 10% penalty we were forced to pay.
We needed to make a change anyways. Since my wife had left her job, she could no longer contribute to the 401k. We needed to make some type of move with the money. Instead of a roll-over, we cashed it out.
We look at things differently
“A bird in the fist is worth two in the bush.” That’s how I sum up the time value of money.
Cash in hand today, has a different value than cash at a future date. The difference is calculated based on your rate of return. The higher returns you can generate, the more valuable cash is right now.
For the last 6 years I’ve made returns between 100% and 200% on capital.
My career has been focused on making far above normal returns. For me, the opportunity cost of leaving money in a 401k making 10% per year was larger than for most.
There’s nothing wrong with making 10%. That’s actually a great return if you’re a “hands-off” investor.
Generating high returns enabled me to live off trading income for 6 years. I didn’t get rich, but It was a good lifestyle. I’ve been blessed to spend an abundance of time with my young children. For my families sake, I wanted to it to continue.
We saw real estate investing as a viable opportunity to pursue that.
Here’s the thing that really turns the normal personal finance advice on its head.
I don’t ever plan on retiring.
This is probably the biggest reason we liquidated our 401k. I don’t have any desire to quit working at 65. As long as I stay involved in entrepreneurship and investing, I don’t think I ever will. Most people don’t feel that way about their profession.
None of this is financial advice. Don’t do what we did. I just wanted to offer an alternative perspective on a common financial question.
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