By J.P. Dahdah, Founder & CEO of Vantage
Imagine a scenario where you have money sitting in a 401(k) or IRA, but you’re strapped for cash.
Liquidity is the problem. You look at your buckets of money and realize the only way you can pay a bill is by taking a withdrawal from your IRA.
This certainly isn’t ideal. Not only will you have to pay ordinary income taxes, but you’ll also have to take a 10% haircut (as an IRS penalty) on the money you withdraw.
There’s got to be another solution, right?
Well, if you have a Self-Directed IRA—a version of the traditional IRA where you have 100% control over how your money is invested—there are some creative options available. And one of the options I often share with clients is known around our office as “financial friends.”
With a Self-Directed IRA, you have the option of lending money to people without pulling the money directly from your portfolio. So, rather than taking a distribution that is taxed, you can find a financial friend who’s in a similar situation and sign a cross-promissory note.
In simple terms, if I need cash, I’ll need to find a financial friend.
Let’s call him John. I lend John money out of my IRA as an actual investment. I do this through a promissory note with interest based on the terms I create. And John, who also has an IRA he doesn’t want to take a distribution from, lends me money out of his IRA. We both use the money for our expenses and pay each other back.
How does this work, exactly?
Step 1: You have to have a Self-Directed IRA set up. With the Self-Directed IRA, you transfer money from your existing custodian, not a taxable event. It takes anywhere from 7 to 10 business days for the transfer to complete.
Step 2: Next, you find a financial friend who wants to lend money to you based on agreed-upon terms. For example, you charge John 4%, and he charges you 4%.
Step 3: Finally, you pay back the loan to John, and he pays back the loan to you. Neither one of you has to take a disbursement. And you can pay for your outstanding bills without any issues (or penalties).
So, the next time you run into a liquidity crunch, it may be time to think outside the box.
Work with experts, like the fine folks at Vantage, to develop strategies like the “financial friends” approach to get you the money you need and avoid expensive penalties.
Start identifying your financial friends today and contact us to learn more about Self-Directed IRAs.
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