What are the cons of taking out ROTH IRA contributions?

23 Replies

My husband and I were thinking of taking some money out of our ROTH IRA for the REI business. The amount we'd withdraw would be around 20% of our overall retirement funds. We are in our 40s, if that matters.

Aside from the risk of losing this money and inability to "return" the funds back to ROTH IRA in a lump sum, are there other serious disadvantages that we should be aware of?

I'll mention that my husband plans to continue his full-time job and making contributions to our retirement funds, and I will be the main person running the business. 

Thank you for your comments!

Best regards,

Ludmila

HHHMMMM,  is this a traditional roth or self directed??    The self directed roth and own real estate and I'm not sure how to respond...

I'm sure @Brian Eastman will be by shortly.

If you don't need the money now, and can wait until you are 59 1/2, I would recommend setting up a Self Directed Roth IRA so that you can do real estate transactions in your Roth. I am currently in the setup process and already have a property that I plan to buy in a few weeks as soon as my transition is complete.

I think you would be better off just saving money outside of your roth to use.  You only have that once chance to get money into a roth, I dont see much upside to using that money.

Worst case scenario you lose 20% of your ROTH.  Best case scenario the investment with the Roth capital into real estate returns a far greater return than the stock market.

Life is short.  Do it.


Franklin

@Ludmila M.

If you expect to make high returns, it is my understanding the roth ira will out perform a traditional ira.  Of course if you flip that around the traditional would be the better choice.  You just need  to do the math based on what kind of gains you expect, to calculate which will result in less taxes.

@Ludmila M.

There is no set answer to a question such as yours, other than "there are a whole lot of factors to consider", with the aim of making the best decision.

The key difference is that if you leave that money in a Roth IRA, all earnings and future distributions are tax-free. That can be a really big pot of tax-free money 15-20 years down the road if you invest it wisely. If you pull the money out, anything you do with that money will be taxed.

Unfortunately, there are a lot of calculators out there to help you compare a Roth IRA to a Tax-Deferred IRA, but there is no easy tool to help you determine what the respective after-tax values of spendable money would be to you in either the Roth or non-qualified funds. You'd need to do that math yourself.

The other big difference, of course, is that the Roth money is tucked away and you can access the money personally now if you take a distribution.  Do you need the money, or do you just want to control the money?

As noted above, if you were to keep the money in a Roth IRA, but move it to a self directed plan, you could then use that to invest in real estate. It would not become "your real estate business", but rather you would become a fund manger for the Roth IRA and decide to deploy the capital into real estate. There are certain rules relating to keeping IRA activities at arm's length that come into play. Because it is a Roth IRA, you could choose to take distributions of the earnings from time to time, instead of taking a big chunk out of the account.

Your licensed tax and/or financial advisor are going to be in the best position to help you look at all of the variables that go into such a decision and gather the facts that will help you think not only for today, but for the long term.

Hi,

Is the Roth the only retirement plan you have? Do you have a 401k, 403b, traditional IRA, etc?

You may want to research on your own for Roths there is some good info on rothira.com

From my experience on wall st, Roths are best for people who are younger (20's, 30's, etc) and have a lower income bracket than someone who has more advanced career. That's because the contributions to a roth are already taxed. Meaning what you are putting in right now into your Roth is taxed already up front. Therefore the earnings and your contributions are free of any additional taxes with the Roth fund. As you grow in your career and earnings power your tax bracket increases and then the benefit of a Roth is more pronounced as you spend more time with it and contribute in past years via your lower income bracket. The big plus here is that there are no penalties to anroth for withdrawing your contributions. However, any earnings on those contributions will be penalized u less they meet the guidelines like spending it on your first house or a family death etc. I would stay away from doing this with a Roth.

A better alternative is a 401k and looking into what is called. ROBS or rollover as a business. You can essentially rollover your Ira or 401k into a business and not be taxed or charged any penalty. Look at guidance financial or google ROBS 401k.

Sorry typo on the last one as my phone doesn't let me post correctly.

The correct term is ROBS and is rollover as a business and the company the specializes in this is called Guidant Financial although there are tons of others like CPA's who can help. This is a good and better format to do this with retirement funds rather than withdrawing them outright yourself and encounter any penalties. This is a loop hole in the irs tax code that allows small business owners start/fund their businesses with retirement funds. But again, your opportunity is reduced with a Roth as this type is strictly geared for special cases as I mentioned earlier like younger people who fall in lower tax brackets. If you start a Roth at a high tax bracket its not as good as a traditional Ira or 401k.

Contributing to a Roth in your 20's when you are at a 20% tax bracket is more beneficial than contributing at 40 and being in a 30% bracket. This is because in your 20's you will take advantage of contributing in a lower tax bracket all those years and allowing your money to grow with minimal taxes up front. Doing it at a high tax bracket will be a disadvantage to you as it will be less money to grow for you. So a Roth and a traditional Ira are geared for different purposes and different types of apropos.

@Ludmila M. ,

My wife and I both cashed out our IRA's to increase our rental portfolio and it was a mixed bag. The money that you contributed to your Roth can be withdrawn tax free, minus the penalty. All funds earned beyond your contribution will be subject to income tax as well as the penalty. As we are still young, we only had about $50K in our accounts, so we ended up with about $40K after all the tax penalty's, however that money has allowed us to purchase several more properties than we could of otherwise. It sinks to pay more money to the government, especially since you already paid taxes on the money once, however if you believe it will allow you to accrue additional properties, and you can stand the pain, it will be well worth it.

Contributions are not taxed, only earnings.  So, if over the past years, say you contributed $20K to the ROTH, you can take that $20K out with no penalty and no tax.  If you contributed $20K and the value is now $100K, the $80K spread is what is subject to early withdrawal penalty.

I have had a SDIRA since 1998 and it is a wonderful vehicle.  If you can somehow avoid taking the money out, that would be ideal...

Originally posted by @James Maher :

I'm sure @Brian Eastman will be by shortly.

If you don't need the money now, and can wait until you are 59 1/2, I would recommend setting up a Self Directed Roth IRA so that you can do real estate transactions in your Roth. I am currently in the setup process and already have a property that I plan to buy in a few weeks as soon as my transition is complete.

That's the thing, we are trying to decide between borrowing from the bank and taking out some of our Roth IRA contributions. SDR IRA is definitely in my plans, but we are not there yet.

Originally posted by @Frank R.:

Worst case scenario you lose 20% of your ROTH.  Best case scenario the investment with the Roth capital into real estate returns a far greater return than the stock market.

Life is short.  Do it.


Franklin

Well, embarrassing to admit, but one of our Roth IRA is returning 4%, the other one is negative, as of today. So, return-wise there is not much of an argument in favor of Roth IRA.

Originally posted by @Russell Brazil :

I think you would be better off just saving money outside of your roth to use.  You only have that once chance to get money into a roth, I dont see much upside to using that money.

 Higher returns? No need for collateral, if compared against bank financing?  This is my line of thinking, but, being a beginner, it can be flawed.

Originally posted by @Brian Eastman :

@Ludmila M.

There is no set answer to a question such as yours, other than "there are a whole lot of factors to consider", with the aim of making the best decision.

The key difference is that if you leave that money in a Roth IRA, all earnings and future distributions are tax-free. That can be a really big pot of tax-free money 15-20 years down the road if you invest it wisely. If you pull the money out, anything you do with that money will be taxed.

Unfortunately, there are a lot of calculators out there to help you compare a Roth IRA to a Tax-Deferred IRA, but there is no easy tool to help you determine what the respective after-tax values of spendable money would be to you in either the Roth or non-qualified funds. You'd need to do that math yourself.

The other big difference, of course, is that the Roth money is tucked away and you can access the money personally now if you take a distribution.  Do you need the money, or do you just want to control the money?

As noted above, if you were to keep the money in a Roth IRA, but move it to a self directed plan, you could then use that to invest in real estate. It would not become "your real estate business", but rather you would become a fund manger for the Roth IRA and decide to deploy the capital into real estate. There are certain rules relating to keeping IRA activities at arm's length that come into play. Because it is a Roth IRA, you could choose to take distributions of the earnings from time to time, instead of taking a big chunk out of the account.

Your licensed tax and/or financial advisor are going to be in the best position to help you look at all of the variables that go into such a decision and gather the facts that will help you think not only for today, but for the long term.

 Brian, thank you for taking time to respond. 

I do need the money to buy an investment property. So, I look at Roth IRA as a source of capital and compare it against other possible sources. Bank financing would be next in line. Looking at it from the worst-scenario prospective, I'd think losing own $$ is safer than defaulting on a bank loan, which will be secured by the investment property+personal guarantees. Or am I wrong?

Originally posted by @Ed D. :

Sorry typo on the last one as my phone doesn't let me post correctly.

The correct term is ROBS and is rollover as a business and the company the specializes in this is called Guidant Financial although there are tons of others like CPA's who can help. This is a good and better format to do this with retirement funds rather than withdrawing them outright yourself and encounter any penalties. This is a loop hole in the irs tax code that allows small business owners start/fund their businesses with retirement funds. But again, your opportunity is reduced with a Roth as this type is strictly geared for special cases as I mentioned earlier like younger people who fall in lower tax brackets. If you start a Roth at a high tax bracket its not as good as a traditional Ira or 401k.

Contributing to a Roth in your 20's when you are at a 20% tax bracket is more beneficial than contributing at 40 and being in a 30% bracket. This is because in your 20's you will take advantage of contributing in a lower tax bracket all those years and allowing your money to grow with minimal taxes up front. Doing it at a high tax bracket will be a disadvantage to you as it will be less money to grow for you. So a Roth and a traditional Ira are geared for different purposes and different types of apropos.

 Ed, thank you so much for your response! This was very informative, as I never heard of ROBS. Now I need to figure out if this will work for us. I'll bring this up to our tax accountant to see if he can help.

In response to your question, we do have other retirement accounts, including traditional IRA and 401k.

Thank you again!

@Ludmila M.

You are correct that it is probably better to risk a specific amount of your own capital on a property than to pledge all of your assets against that debt.  Properly structured, things can be insulated and isolated, but in general you are on the mark.

The ROBS plan cannot be funded with Roth IRA funds, but would be something you could look into with tax-deferred retirement savings. The plan is for capitalizing a business such as a restaurant franchise or a real estate development company (flips), not for passive income such as rentals.

@Ludmila M.

Sorry for the misunderstanding.  Allow to me expand on my answer.

I wrote:

If you expect to make high returns, it is my understanding the roth ira will out perform a traditional ira. Of course if you flip that around the traditional would be the better choice. You just need to do the math based on what kind of gains you expect, to calculate which will result in less taxes.

Say you have and invest 10k in a roth ira, and you make 90k on the investment, you will pay no taxes on 90k. But you did pay taxes up front on that 10k.  Pretty good right.

Now on the flip.

Say you have and invest 10k in a traditional ira and you make the same 90k on the investment, you will pay taxes on the 90k but not the 10k.

This investment had a high yield and shows the tax benefits for such a transaction.  If you do the same math on a low yield investment you will see how the traditional roth would have been the better choose.

Understand the scenario does not take into account many other factors, such as income levels most folks have at different points in  their life and I am no by no means an expert in any of this.  This is, however my understanding.  

Hope that clears it up.

Thanks, @Account Closed ! No problem that you addressed something I didn't specifically asked, you still gave useful information. I probably didn't word my question in the best way, which caused confusion. I apologize if this is the case.  

Ludmila,

Bigger Pockets provides the world's best place for real estate knowledge.  But being honest, we as a community, don't know much about traditional investments like Roths. I encourage you to verify all of this with a certified financial planner. Still, here are my take.

You can take your contributions out of a Roth IRA without penalty or taxes as long as those contributions have been in your Roth for 5 years. Note that this is limited to your contributions, and is not true for any return those investments have made.

You mentioned part of a key point:  Taking money from your Roth will indeed decrease future Roth earnings.  The obvious side of this is simply returns.  But just as big of an issue is taxes...  Roth IRAs are extremely tax advantaged!!!  Real Estate can be tax advantaged as well, but you're still moving money from a tax advantaged situation to one that probably doesn't have the same level of tax benefits.  For this reason, it's preferable to invest new money into real estate (though I know this is not always an option).

I'm also very worried by the comments you made about your Roth returns last year.  Generally speaking, IRAs are long term investments, and it should never ever matter what happens over a 12 month period.  How have those investments done over the last 5 year, or 10  year period?  Or, more importantly, does your current allocation still align to your long-term goals?

I may be reading between the lines a bit, but it sounds like you may be considering using capital from your Roth to avoid taking out a mortgage.  Is that true?  If so, I would generally advise against this.  Using mortgages is one of the big reasons that real estate returns can be so high.  

Should you take the money out of your Roth?  That's a decision that you need to make for yourself.  It's a big big decision, and one with huge long-term implications.

Either way, Happy Hunting!