Cashing Out Teacher Retirement -- Jump or Stay Safe?

Question

I'm a new brand new Real Estate Investor.  I did my very first deal this past month.  Bought a SFR (4-2) with a tenant already installed and approximately $450 free cash flow before repairs and Capex.  I'm banking all of that cash flow toward the next down payment along with everything I can save from my "real" job.

So, looking for advice on whether to cash out my Texas Teacher Retirement (about 100k before taxes & penalty) to put toward the down on two or three more rental properties. I no longer work in the school system, so I am no longer contributing to the pension.

Here are the facts: If I leave it, I can retire at age 62 and draw approximately 40k per year until I pass away.  If I withdraw it, I have to pay income taxes plus the 10% penalty to the IRS for early withdrawal.

I figure I can turn that into 2 or 3 down payments on SFR's that will cash flow about $400 to $500 per month each or perhaps look into a duplex or quadplex...I haven't run numbers on what those cash flow.

Any advice or angles I'm not seeing with this.  Thanks in advance for your perspective.

Michael Le · Answer

I think you should be able to roll your Texas Teacher Retirement (it's a 401(a) plan I believe) over to a self-directed IRA. Then you can invest from the IRA and you won't take a penalty since you're not cashing it out. There are restrictions to doing it this way as the money has to stay within the IRA and can not benefit you in anyway (until you retire that is).

Tagging @Dmitriy Fomichenko to help you out with this.

Michael Le · Answer

I wouldn't be too quick to say that $40k a year 21 years from now is worth more than $100k today. Time Value of Money is a powerful concept. That $40k a year doesn't start for 21 years so the present value of that money is lower than you would think. You could grow that $100k to $400-500k after 21 years with jut 7-8% return on your money. You could get that relatively passively as a private lender. You could get more than that by more actively investing that money. Of course you could lose it too.

But if you got it to $500k you could get an annuity at that time that provides you similar numbers. Point is I don't think it is clear cut.

Mike Cumbie · Answer

Hi @Brad Gibson,

I am by no means an expert and especially not an expert in retirement. However I would take 40K a year every year instead of 100K today. You are going to be fighting to get that 100K to make you 40K a year (I figure more like 8K in the short term that will gradually increase).

Best of luck in whatever you decide!

Brad Gibson · Answer

@Dmitriy Fomichenko

Thank you for the response. Yes. If I leave the money with the Teacher Retirement System until I turn 63 (21 years from now), I can collect approximately 40k per year. The pension formula is complicated, but that should be in the ballpark.  All of that assumes the Texas Legislature doesn't loot the pension & repurpose for other intentions which has been attempted in the last couple of sessions.

While I see how 40k per year guaranteed would be hard to replicate, on a cash in the retirement account basis, if my wife and I are already maxing out 401k contributions with our current employers, would you still advise against trying to kick start REI now with the withdrawn proceeds?

10 rent homes of at least 100k paid off cash flowing 1k per month apiece in 10 years sounds like it could be a lot more than 40k till I kick the bucket.  Plus it leaves something to my wife and or son.

Thank you for engaging with me as a thinking partner.

Mark Nolan · Answer

@Brad Gibson

Yes a self-directed IRA can incorporate a non-recourse loan but it will subject the IRA to UDFI (

https://www.irs.gov/irm/part7/irm_07-027-008.html).

That is why it is better to open a solo 401k because a solo 401k is not subject to UDFI.

For a list of IRA lenders visit the following:

https://www.biggerpockets.com/blogs/3441/51027-nonrecourse-loan-debt-for-self-directed-solo-401k-investment

Dmitriy Fomichenko · Answer

@Brad Gibson

The self-directed IRA might work for you, but you can only fund it with IRA or employer sponsored plan such as 401k that is with past employer only. If you have a 401k with your current employer and not reached retirement age yet - you will not be able to move those funds.

Did you say you can cash out TX Teacher Retirement of about $100K before taxes/penalties? That means that after you factor taxes/penalties you will end up with about 40% less. But if you kept it - you could get $40K/yr for a life? I would keep it, it is very unlikely you can get such income from REI with those funds. But even if there was a possibility - there would be risk involved but the income from your pension would be guaranteed. No brainier to me unless I'm missing something...

The loan for an IRA must be non-recourse. There is only a handful of lenders who specialize in these kind of loans, you can get a list here:

https://www.biggerpockets.com/blogs/2810/50272-lis...

I do have one lender who can get a loan from Freddie, but the min. loan amount is $750K. However they offer largest LTV (up to 83%) and the lowest rates.

Brad Gibson · Answer

Wow. Hadn't thought about a self-directed IRA.

Allow me to give some additional context. I'm currently blessed to be able to sock away the max contribution to a 401k with my current company & get a near dollar for dollar match from my employer.

My wife & I have approximately 300k currently in traditional 401k plans & will continue to max those out each year.

The thought was to jump start the REI portfolio in an attempt to reach a tipping point & replace a significant portion of our current monthly income with the added bonus of equity & possible appreciation.

Still think the self directed IRA is the way to go?

In addition, can the IRA LLC borrow from Fannie or Freddie?  If not, then financing deals will need to be a little more creative.

Dmitriy Fomichenko · Answer

@Michael Le thanks for the mention!

Brad, there are number of factors you need to consider such as investment goals, risk tolerance, investment experience, etc. You are welcome to contact my office and request complimentary consultation so that I can learn more about your goals and then be in a better position to give you a recommendation.

Mark Nolan · Answer

@Brad Gibson

Good question.

If you are looking to continue to grow your retirement funds, you can transfer the former employer plan to a self-directed IRA, or a solo 401(k) if you are self-employed. You can then invests the retirement funds in real estate directly. All the income will flow back to the IRA or solo 401(k) and continue to grow on a tax-deferred basis. This is a way to continue to grow your retirement plan by investing in real estate. Following is the differences and similarities between an IRA  and a solo 4K.

The Self-Directed IRA and Solo 401k Similarities

• Both were created by congress for individuals to save for retirement;
• Both may be invested in alternative investments such as real estate,  precious metals tax liens, promissory notes, private company shares,  and stocks and mutual funds, to name a few;
• Both allow for Roth contributions;
• Both are subject to prohibited transaction rules;
• Both are subject to federal taxes at time of distribution;
• Both allow for checkbook control for placing alternative investments;
• Both may be invested in annuities;
• Both are protected from creditors;
• Both allow for nondeductible contributions;
• Both are prohibited from investing in assets listed under I.R.C. 408(m); and

The Self-Directed IRA and Solo 401k Differences

• In order to open a solo 401k, self-employment, whether on a part-time or full-time basis, is required;
• To open a self-directed IRA, self-employment income is not required;
• In order to gain IRA checkbook control over the self-directed IRA funds, a limited liability company ( IRA LLC)  must be utilized;
• The solo 401k allows for checkbook control from the onset;
• The solo 401k allows for personal loan known as a solo 401k loan;
• It is prohibited to borrow from your IRA;
• The Solo 401k may be invested in life insurance;
• The self-directed IRA may not be invested in life insurance;
• The solo 401k allow for high contribution amounts (for 2016; the  solo 401k contribution limit is $53,000, whereas the self-directed IRA  contribution limit is $5,500);
• The solo 401k business owner can serve as trustee of the solo 401k;
• The self-directed IRA participant/owner may not serve as trustee or  custodian of her IRA; instead, a trust company or bank institution is  required;
• When distributions commence from the solo 401k a mandatory 20% of  federal taxes must be withheld from each distribution and submitted  electronically to the IRS by the 15th of the month following the date of  each distribution;
• Rollovers and/or transfers from IRAs or qualified plans (e.g.,  former employer 401k) to a solo 401k are not reported on Form 5498, but  rather on Form 5500-EZ, but only if the air market value of the solo  401k exceeds $250K as of the end of the plan year (generally 12/31);
• When funds are rolled over or transferred from an IRA or 401k to a  self-directed IRA, the amount deposited into the self-directed IRA is  reported on Form 5498 by the receiving self-directed IRA custodian by  May of the year following the rollover/transfer.
• Rollovers (provided the 60 day rollover window is satisfied) from an  IRA to a Solo 401k or self-directed IRA are reported on lines 15a and  15b of Form 1040;
• Pre-tax IRA contributions on reported on line 32 of Form 1040;
• Pre-tax solo 401k contributions are reported on line 28 of Form 1040;
• Roth solo 401k funds are subject to RMDs;
• A Roth 401k may be transferred to a Roth IRA (Note that from a  planning perspective, it may be advantageous to transfer Roth Solo 401k  funds to a Roth IRA before turning age 70 ½ in order to escape the Roth  RMD requirement applicable to Roth 401k contributions including Roth  Solo 401k contributions and earnings.);
• Roth IRA funds are not subject to requirement minimum distributions (RMDs);
• The fair market value (FMV) of assets held in a self-directed IRA is reported on form 5498;
• The fair market value of assets held in a solo 401k are reported on Form 5500-EZ;
• At termination, the solo 401k is required to file a final Form 5500-EZ and 1099-R; and
• At termination, the self-directed IRA is only required to file a form 1099-R.

Cashing Out Teacher Retirement -- Jump or Stay Safe?

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