Should I pay debt with my IRA? or should I invest the IRA?

39 Replies

Hello ALl! first post here... My name is Adriana Vergara, I´m 35, single, no kids. Journalist background (worked in CNN for 8 years) I Now I have a soccer school in Atlanta GA, and also I became an apprentice in real state thanks to COVID and my boyfriend.

I´m trying to Straiten the boat here, to be able to start buying real estate...

So....

- I´m $34,373 in debt on credit cards. (I know.. it just happened and now it's time to make things right).
- At the same time, I have an IRA with a $68,806 net worth.

I have spent the past year helping and learning with my boyfriend who´s a realtor and who 4 years ago started doing flips. I have spent the past months reading, learning, listening to podcasts, youtube channels. etc.. and definitely I know I want to do this, I want to start with something, so one day I can talk about my own rental portfolio.

I have never bought a house before, so I still have that option to buy with a 3 or 3.5% down, but of course, my DTI is just too high...

So... the question is... Should I withdraw part of the IRA to:

  • A- Pay the total of your debt!
  • B- Pay part of the debt (at least leave it in 30%) and use the rest for a downpayment
  • C- Don´t use your IRA money to pay the debt! just find the way to use someone else's credit (I have that option as well) you put the down and go 50-50 with that person on the property
  • D- YOU have no idea what are you talking about, TRY TO DO THIS INSTEAD (please give me some suggestions!!!)

Here´s the breakdown of my cards:

  • AMEX - $19,135 (I have an installment plan, at 7.99% APR, they won't close my account when I pay off the card) (credit line 22K)
  • VISA WellsFargo - $6,865 at 21.99% APR (credit line $7,350)
  • DISCOVER - $3.369 at 11.99% APR (credit line 7k)
  • CHASE Freedom - $5,003 at 22.99% APR (credit line $5,500)

I have no more savings.


About my income: I pay myself around 3K a month and I get a 20% commission on every transaction when helping my boyfriend representing sellers and buyers.

I'm so compromised with this, that I just sold my car (I had a loan for 19k and got 20.5K for it) I know I can deal without a car right now and I want to lower down my monthly expenses to see where else I can put my money.

So... is it a good idea to use the IRA money to pay debt? or how else can I use it?

PS. I already know about the 10% taxes that I'll get charged if I decide to withdraw from the IRA, I know that I will pay a penalty (not in the first 10K if I use them in a first house). But hey... I'm just trying to find a way to start from 0 or to at least do something.

Thanks all for reading all this way!! In advance, I appreciate all the comments and suggestions.

Best regards.
Adriana.

Since you are self employed I'm guessing your net income is zero, which means the debt doesn't mean anything in terms of debt to income ratios... If income shows zero, it doesn't matter.

You will pay more than 10% on withdrawal of IRA - depends on what tax bracket and state you are but probably like 28%. Do not withdraw IRA to pay cards. If you are in terrible hardship you can get a loan against the IRA but don't do it to pay credit cards.

Get a second job, maybe something for cash and skinny down on what you spend to nothing. Start paying Chase and Wells an extra $500 a month and make all the other regular payments early. 

What you can to to get in position to qualify for a loan is start to make ALL deposits into one and only one account. After 12 months we can review what income you show, and you should then only have AMEX and Discover with smaller balances. 

@Caroline Gerardo , agree with you that pulling out IRA funds early to pay off credit cards would not be a wise move and can cost 30-50% in taxes and penalties. BUT you can't get a loan against IRA, that is not possible!

Adriana, welcome to BP and congrats on the first post! Wishing you the best in your REI journey!

@Caroline Gerardo BUT, since you are self-employed you could open a solo 401(k) and roll your IRA into that. Then you could take a loan of 50% or $50,000 (whichever is less, but in your case will be 50%, or the $34K you need) from the 401(k) and apply it to your credit card debt. I think (and @Dmitriy Fomichenko could fill in or correct the facts here) that you will need to amortize that loan over 5 years and charge yourself a fair interest rate.  That said, the interest rate will be less than all of the above credit cards, especially the non-AMEX ones.  Your payment on a 5 year amortization will be high, but it might be the hurdle you need to jump in order to both free yourself from this situation AND have a monthly payment in your budget that you'll be able to re-direct productively once you've paid off the loan.

You are currently paying $382 a month in interest alone.  To make a 1% minimum monthly payment, you are paying another $343 in principal, and it will take 20+ years to pay it off (I haven't done the math, but your statements will show you this.).  That's north of $700 a month, which is higher than your 401K loan payment would be at 3.25%.  And at 3.25%, your interest costs would be less than $100 a month and falling, with 85% or so of your payment going towards principal payback that you can get working for you again in your 401K.

And, the 50% of the 401K you didn't loan to yourself will still be working for you in whatever investments you choose.

So what if this takes 5 years?  At the end you are debt-free, have $700 a month in your budget to invest as you please, you haven't lost 30% or more of your capital to taxes (remember that the amount you withdraw is also income and will affect your tax bracket!), you haven't forfeited your retirement account to pay off your 30-year-old-self's debts, and you should be ready to rock!  Just never put something on a credit card again that you don't intend to pay off at the end of the month, regardless of the teaser rate or the rewards offered.

Good luck!

Edit: you might not be able to open a solo 401(k) depending on the nature of your soccer school business.  Namely, if it has employees.  But, you could look at creating a 401K plan for you and your employees and doing the same thing outlined above.  It's a different beast, but done right it will still be well-worth it.  I don't believe you HAVE to match employee contributions unless you are looking to safe harbor your own contributions to the 401K.  So, maybe you could create it, offer it to the employees, make no contributions yourself (for now, at least), and implement the above strategy.  It would go through your custodian at that point, since it wouldn't be a solo 401K.

Originally posted by @Caroline Gerardo :

Since you are self employed I'm guessing your net income is zero, which means the debt doesn't mean anything in terms of debt to income ratios... If income shows zero, it doesn't matter.

You will pay more than 10% on withdrawal of IRA - depends on what tax bracket and state you are but probably like 28%. Do not withdraw IRA to pay cards. If you are in terrible hardship you can get a loan against the IRA but don't do it to pay credit cards.

Get a second job, maybe something for cash and skinny down on what you spend to nothing. Start paying Chase and Wells an extra $500 a month and make all the other regular payments early. 

What you can to to get in position to qualify for a loan is start to make ALL deposits into one and only one account. After 12 months we can review what income you show, and you should then only have AMEX and Discover with smaller balances. 

Hello Caroline. Thank you so much for the time that you took to answer my question. You just gave me so much valuable information.

Question, do you know anything about SDIRA? Someone suggested transfering the IRA to a SDIRA but I know nothing about it.

What’s your opinion about this?

Originally posted by @Dan Schwartz :

@Caroline Gerardo BUT, since you are self-employed you could open a solo 401(k) and roll your IRA into that. Then you could take a loan of 50% or $50,000 (whichever is less, but in your case will be 50%, or the $34K you need) from the 401(k) and apply it to your credit card debt. I think (and @Dmitriy Fomichenko could fill in or correct the facts here) that you will need to amortize that loan over 5 years and charge yourself a fair interest rate.  That said, the interest rate will be less than all of the above credit cards, especially the non-AMEX ones.  Your payment on a 5 year amortization will be high, but it might be the hurdle you need to jump in order to both free yourself from this situation AND have a monthly payment in your budget that you'll be able to re-direct productively once you've paid off the loan.

You are currently paying $382 a month in interest alone.  To make a 1% minimum monthly payment, you are paying another $343 in principal, and it will take 20+ years to pay it off (I haven't done the math, but your statements will show you this.).  That's north of $700 a month, which is higher than your 401K loan payment would be at 3.25%.  And at 3.25%, your interest costs would be less than $100 a month and falling, with 85% or so of your payment going towards principal payback that you can get working for you again in your 401K.

And, the 50% of the 401K you didn't loan to yourself will still be working for you in whatever investments you choose.

So what if this takes 5 years?  At the end you are debt-free, have $700 a month in your budget to invest as you please, you haven't lost 30% or more of your capital to taxes (remember that the amount you withdraw is also income and will affect your tax bracket!), you haven't forfeited your retirement account to pay off your 30-year-old-self's debts, and you should be ready to rock!  Just never put something on a credit card again that you don't intend to pay off at the end of the month, regardless of the teaser rate or the rewards offered.

Good luck!

Edit: you might not be able to open a solo 401(k) depending on the nature of your soccer school business.  Namely, if it has employees.  But, you could look at creating a 401K plan for you and your employees and doing the same thing outlined above.  It's a different beast, but done right it will still be well-worth it.  I don't believe you HAVE to match employee contributions unless you are looking to safe harbor your own contributions to the 401K.  So, maybe you could create it, offer it to the employees, make no contributions yourself (for now, at least), and implement the above strategy.  It would go through your custodian at that point, since it wouldn't be a solo 401K.

Dan, I think you just gave me the solution right here.

I already asked my payroll company about creating a 401k to transfer my IRA and then getting the loan. APR will be 4.5% and aince Ill be paying it back to myself, it makes so much more sense.

Also... hoy important is to pick the institution to have the 401K? How should I pick where to have it?

Someone else suggested a SDIRA... do you known  anything about this?

@Adriana Vergara

If you are self-employed - you are eligible for truly self-directed Solo 401k plan. It has several major advantages over SD IRA such as contribution limit 10X higher of an IRA (up to $58,000 for 2021), exempt from UBIT on leveraged real estate, no custodian needed = checkbook control and low cost, ability to invest tax-free utilizing Roth sub-account, and most important for you is loan feature. You can borrow from your 401k plan up to 50% of the balance for any need. This would be much better than taking early distribution and paying taxes and penalties as a result. 

Originally posted by @Caroline Gerardo :

@Dmitriy Fomichenko I can refer you to a method to borrow against an IRA or 401k

Caroline, according to the IRS, using your IRA as a security for the loan is prohibited:

https://www.irs.gov/retirement...

I am curious to see what strategy you are referring to, please share. 

@Adriana Vergara Glad to help.

SDIRAs are simply an IRA with a custodian that allows for a much broader range of investment opportunities (within the confines of IRS regulations, of course). An IRA opened at TD Ameritrade can invest only in what TD Ameritrade offers (stocks, bonds, mutual funds, and for some investors, options and futures). An SDIRA allows for investment in all of that plus real estate, lending, cyrpto currency, precious metals, etc., so long as it doesn't create a prohibited transaction.

If you have a burning desire to come back to the IRA structure in the future, ask your payroll provider if you can include an in-service distribution option, and what the ramifications of that would be. An in-service distribution allows a participant to rollover 401k assets to another plan (like an SDIRA) prior to separating from the company. This may or may not be worth the trouble right now, but it doesn't hurt to ask while you still can.

Good luck, and keep us posted!

@Adriana Vergara just saw your additional question while reading through Dmitriy's good replies.  The self-directed solo 401(k) he describes is the best kind of vehicle, in my opinion, but my understanding is that if you have full-time employees in any of your businesses (the help you provide your boyfriend is probably also self-employment income, and I doubt you have a full-time employee in turn helping you), you are not able to open a solo 401(k).  Regular 401ks are available from many vendors, including places like Vanguard, I think.  It's not discussed much here on BP, because the majority of people are self-employed and engage only contractors for projects as opposed to fulltime employees.

If you believe you are eligible for a solo 401k, I strongly suggest you connect with Dmitriy.  If not, your payroll provider may be a good advisor for you.

Bottom line: choosing a provider is very important.  In the solo 401k route, you'll want some who is both on top of the applicable laws AND communicates them clearly and thoroughly to you, and in the non-sol0 401k route, you'll want a company that doesn't charge you an arm and a leg and also gives you (and your employees) access to a decent range of investment opportunities.

@Adriana Vergara As you own a soccer school you must have been affected to some degree by covid? This allows you much more flexibility to use the IRA. Consult a tax professional but you should avoid the 10% penalty and have more time/flexibility to pay the taxes. Going a bit against the grain here but I say you use it and pay off those loans. You'd still have a retirement nest egg but its going to be the rare retirement fund that returns 21.99%, which is the return you get for retiring that debt.

Not saying its ideal, but I think in your situation you will be in a much stronger start for real estate ventures, not to mention the feeling of a clean slate. Your finances are essentially a crisis situation, so that should be the priority over future savings

continuing here. If you paid everything off would still have about 30K in retirement savings and now you are 35, single with a 30K retirement account and no crippling debt. And you can start taking those debt payments and putting them into real estate or into a retirement account to catch up.

If you are paying yourself 3K a month even with some robust commissions you are unlikely to be in a very high tax bracket (15%?) even after a withdrawal. Without the penalty and a 3 year window to spread out the income hit? I'd be shocked if you took much of a hit at all. So the top amount % you should have to pay is 25% but over 3 years (see above covid stuff) and you might be looking at much, much less. Consult a CPA

Not pleasant, but I would still do it if I was in your shoes. You need money to make money and you are laying out too much of it to cover old debts. I know the rule of thumb is never to touch it, but I think your situation qualifies. If you are betting on yourself give yourself the best odds of success. Good luck!

@Adriana Vergara

Do not steal from your future self with an IRA distribution.

You need to start a hustle. Side hustle, you need to increase your income. If this is getting your own real estate license, it’s only 63 hours (at least here in Florida), you are doing the work for your boyfriend. You now know how. Get 100% of your sales, not just 20%. He may not be happy, but put yourself first.

Go to thrift stores in the best area of town and buy expensive clothes with tags for pennies on the dollar and list them on poshmark or Mercari. Save every one of those dimes and put them directly towards your cards.

Get a bartending job. Or remote cold calls. Stash cash - 100% towards your credit cards.

Although I don’t believe on Dave Ramsey’s policy against debt leverage when it comes to real estate, start listening to some of his podcasts. Start the baby steps. Just to put yourself into the position to start investing in real estate. Til you blast this debt, you don’t have money to put towards real estate. Your interest rates are too high. Returns on real estate investments are awesome, but they are not guaranteed 20% + which you are currently paying on this debt.

@Dmitriy Fomichenko  

1. I was speaking of getting a loan against her IRA or if an employer owned 401k the "company" can structure a hardship loan which her debt is a hardship - not to get a mortgage

2. Mortgage Borrowers can use IRA or 401k for an asset depletion loan where no IRS returns are used (not a loan against the account)

3. Mortgage Borrowers can also use IRA or 401k as reserves for a loan

SDIRA - self directed IRA read the fine print about the fees, and ins and out charges. You could put half in a Fidelity IRA which has no fees to trade, and half in a SDIRA that you plan to use for real estate. I firmly suggest that you do not but real estate as a limited partner, the general partner always takes the pie.

Originally posted by @Jonathan R McLaughlin :

@Adriana Vergara As you own a soccer school you must have been affected to some degree by covid? This allows you much more flexibility to use the IRA. Consult a tax professional but you should avoid the 10% penalty and have more time/flexibility to pay the taxes. Going a bit against the grain here but I say you use it and pay off those loans. You'd still have a retirement nest egg but its going to be the rare retirement fund that returns 21.99%, which is the return you get for retiring that debt.

Not saying its ideal, but I think in your situation you will be in a much stronger start for real estate ventures, not to mention the feeling of a clean slate. Your finances are essentially a crisis situation, so that should be the priority over future savings

 

Good option, but I think this expired December 31, 2020 under the CARES ACT. She would have had to take the distribution last year. 

Originally posted by @Caroline Gerardo :

@Dmitriy Fomichenko  

1. I was speaking of getting a loan against her IRA or if an employer owned 401k the "company" can structure a hardship loan which her debt is a hardship - not to get a mortgage

2. Mortgage Borrowers can use IRA or 401k for an asset depletion loan where no IRS returns are used (not a loan against the account)

3. Mortgage Borrowers can also use IRA or 401k as reserves for a loan

Caroline, the IRS rules are very clear: you can not get a loan against IRA. Not possible! Asset depletion loan is not realistic in this case. No. 3 is irrelevant here, she is looking for ways to pay off her credit card debt.

Originally posted by @Dmitriy Fomichenko :

@Adriana Vergara

If you are self-employed - you are eligible for truly self-directed Solo 401k plan. It has several major advantages over SD IRA such as contribution limit 10X higher of an IRA (up to $58,000 for 2021), exempt from UBIT on leveraged real estate, no custodian needed = checkbook control and low cost, ability to invest tax-free utilizing Roth sub-account, and most important for you is loan feature. You can borrow from your 401k plan up to 50% of the balance for any need. This would be much better than taking early distribution and paying taxes and penalties as a result. 

Dmitriy I just read your article about the solo 401k, amazing information!! Thank you for that.

so, I have a Non-profit and an LLC (Scorp), both related with my soccer academy. Just this year I started payroll in the scorp (2 employees me and my partner) my understanding is that I will not be able to go with the solo 401k with the scorp, Correct? Is there any option for nonprofits?
 

On the other hand, I keep working as a 1099 for my boyfriend who is a Realtor. That’s how I could quialify to creat a solo 401K?


what’s better tho... opening a solo 401K or a regular 401K with the scorp? 

The main purpose is transfering my IRA so that I can get a loan from my funds.

Originally posted by @Dan Schwartz :

@Adriana Vergara Glad to help.

SDIRAs are simply an IRA with a custodian that allows for a much broader range of investment opportunities (within the confines of IRS regulations, of course). An IRA opened at TD Ameritrade can invest only in what TD Ameritrade offers (stocks, bonds, mutual funds, and for some investors, options and futures). An SDIRA allows for investment in all of that plus real estate, lending, cyrpto currency, precious metals, etc., so long as it doesn't create a prohibited transaction.

If you have a burning desire to come back to the IRA structure in the future, ask your payroll provider if you can include an in-service distribution option, and what the ramifications of that would be. An in-service distribution allows a participant to rollover 401k assets to another plan (like an SDIRA) prior to separating from the company. This may or may not be worth the trouble right now, but it doesn't hurt to ask while you still can.

Good luck, and keep us posted!

I’m learning so much over here!!!! 👏🏻👏🏻 can’t thank you enough. Thank you for your time!