Solo 401/SD IRA, vs Cash Out, vs Whole Life Insurance

Tax, SDIRAs & Cost Segregation
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Solo 401/SD IRA, vs Cash Out, vs Whole Life Insurance

Nathan Herber
Greenville, SC · Member since 2019 · 4 posts · 1 vote

Hi Bigger Pockets Community! Merry Christmas and Happy New Year to you and your family.

So, I am going down the rabbit hole of researching moving my 401k and my wife's 403b from a former employer to a Solo 401k and a personal Roth IRA to a Self Directed Roth IRA. My question why did you decide to either cash out your retirement investments (and pay the taxes) or, moved them to a solo 401k and/or SD Roth IRA? I have read most of the regulations such as, UBIT tax, Solo/SDIRA can only be applied to non-recourse loans, solo 401k is more flexible than the Roth IRA, and it's better to set up an LLC for the Solo 401k to create a tax ID number for plan contributions etc.

I have to make a decision to move my retirement funds with my former employer's investment institution by March. My goal is to position my retirement funds so they are ready to deploy toward a deal. My three strategies are:

  1. 1. Cash out, pay the UBIT tax and report the additional income that year, and if a deal is made next year, implement a cost segregation on the multifamily property to help reduce the taxable income.
  2. 2. Move the funds to a Solo 401k / Roth IRA. I'm more limited to certain deals as a JV, but I can move the funds now with no penalty, taking advantage of the stock market/investment fund's all-time-high, and cash out later (or partially) if a recourse loan deal becomes available.
  3. 3. Whole Life: With option #2, I must pay myself back over “x” years. While I’m still getting my head around this concept, the 3rd option is to cash out my retirement and place it into a Whole Life Insurance vehicle (infinite banking concept) to take loans against it for around 5% for real estate investments while the policy accuses/compounds over time, ie. 5 years (super simplistic for the purposes here).

I'm in my late 30's if that plays a factor into your answer.  I'm interested to hear how you came to your decisions and lessons learned.  

Thank you!

Nathan

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Zachary Paschke
Scranton, PA · Member since 2017 · 168 posts · 137 votes
6y

The gentlemen above are mostly right. I think you understand that. Life insurance is not an investment. Term insurance is less expensive than whole life (because term rarely pays out). It is a hedge against investments.

A whole life policy with Guaranteed interest at 4% and a dividend generally around 5% Is a compelling offer. As you know. If you structure it properly you’ll have more cash value than you paid into the policy. You can borrow against the cash value (generally it will cost the amount of guaranteed interest + 1%. In this example 5%). A company with a strong dividend will continue paying you more than the coast of the loan. 

I’m not aware of any other financial instruments that will let you borrow against it and pay you more than the coast of the loan while you invest the money from the loan. Especially considering a life insurance loan is generally tax free. 

As an agent, I can make more money off a term policy (why agents like the buy term and invest the difference concept- don’t get me wrong. I do too) than a properly structured whole life policy. The more favorable the policy for you, the less I make and the more work it takes on my side.

That said @Carl Fischer is right. Life insurance won’t keep you from having the tax burden of cashing out your investment. That’s a real consideration. 

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  • Carl FischerPro Member
    Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
    6y

    @Nathan Herber

    I like the  move to a solo 401k and Roth SDIRA. You move from “forever taxed” to “never taxed” group for the long run.  
    you can have several strategies you don’t have to cash out everything and pay the penalty. Do what you need to now for cash. Think about using all 3 strategies based on your goals and timeframe. Think about the short and long game.  
    all options you mention have a place. They are not mutually exclusive. I wish I was where you are when I was 30. Think and grow rich. 
    I have used all the strategies you discuss-my least favorite was taking the penalty for the immediate unfettered use of the cash but it did help. Self direction just gives you way more options. Life insurance gives you 2 sources of income for the same money. I hope this helps. 

    [email protected]215-283-2868
    2Reply
  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 917 posts · 266 votes
    6y

    Don t mix investing with life insurance. I have never heard a real life true story from someone who got rich off of their life insurance policy....unless it was the agent/ salesman!

    3Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    6y

    I second @Todd Goedeke recommendation: using life insurance as an investment would be poor financial choice. Be sure to buy adequate amount of term life insurance to protect your loved ones in case something happens to you, then focus deploying all of your available capital to acquire real investments (rentals, trust deeds, syndications, etc.)

    1Reply
  • Zachary Paschke
    Scranton, PA · Member since 2017 · 168 posts · 137 votes
    6y

    The gentlemen above are mostly right. I think you understand that. Life insurance is not an investment. Term insurance is less expensive than whole life (because term rarely pays out). It is a hedge against investments.

    A whole life policy with Guaranteed interest at 4% and a dividend generally around 5% Is a compelling offer. As you know. If you structure it properly you’ll have more cash value than you paid into the policy. You can borrow against the cash value (generally it will cost the amount of guaranteed interest + 1%. In this example 5%). A company with a strong dividend will continue paying you more than the coast of the loan. 

    I’m not aware of any other financial instruments that will let you borrow against it and pay you more than the coast of the loan while you invest the money from the loan. Especially considering a life insurance loan is generally tax free. 

    As an agent, I can make more money off a term policy (why agents like the buy term and invest the difference concept- don’t get me wrong. I do too) than a properly structured whole life policy. The more favorable the policy for you, the less I make and the more work it takes on my side.

    That said @Carl Fischer is right. Life insurance won’t keep you from having the tax burden of cashing out your investment. That’s a real consideration. 

    3Reply
  • Thomas RutkowskiPro Member
    Financial Advisor · Boynton Beach, FL · Member since 2015 · 833 posts · 798 votes
    6y

    @Nathan Herber

    I've done an analysis/comparison of the approaches you've described. I have a spreadsheet model that I used to do the analysis. All the inputs are user adjustable to account for growth assumptions, tax rates, etc.

    The cash in hand vs cash in a tax-deferred account is entirely up to personal preference. We all need to eat and pay bills today, so there is a lot to be said for cash in hand.

    I'm personally several years into liquidating my own SD-IRAs and moving the proceeds to High Cash Value Life Insurance. 

    1. I can put the entire amount to work. i.e. if I take a $50K distribution, I DO NOT have the taxes withheld at the time of distribution. I make a 50K premium payment with the money. LATER, when the the taxes are due, I use a policy loan to pay both the taxes and the 10% penalty. I'm doing a 5 year funding.

    2. This creates a lien against the policy's cash value, but It also creates a "hole" that I can fill later. I can avoid fees by getting the cash into the policy by paying back the loan rather than paying premium.

    3. I don't have to wait till I'm 59.5 to access the funds. I can leverage the cash value from now till the time I retire.

    Here's the logic behind this: Life Insurance Cash Value can generate 2 to 3 times the retirement income of money in traditional retirement assets. So even if I lose the ability to generate income from the cash value that is securing the loans to pay the taxes, the remaining cash value will still generate more retirement income. The reason is explained in this blog post...

    https://www.biggerpockets.com/member-blogs/7595/86513-should-you-buy-term-and-invest-the-difference

    I am personally using an Indexed UL, not a Whole Life. Don't believe the hype. The cash value of an IUL will capture a portion of the Equity Premium with no less risk than a Whole Life. For two identically-designed policies (same premium, same death benefit), the IUL will generate more cash value over the long run than the WL.

    This is a good primer on Life Insurance that explains the REAL difference between WL and IUL...

    https://www.biggerpockets.com/...

    Good luck!

    2Reply
  • Nathan Herber
    OP
    Greenville, SC · Member since 2019 · 4 posts · 1 vote
    6y

    Happy New Year!  Thank you all for your valuable insights which is helpful to weigh the options. As several stated above, I am leaning more toward multiple structures verses a one-size-fits all long/short term strategy.

    If I were to cash out partly, my strategy would be only when an LOI is accepted and due diligence has been preformed. Then, hire a cost segregation specialist to apply accelerated deprecation on the property which flows through one's personal income to minimize the loss in taxes.

    One small follow up question is a Solo 401k a QRP or is a QRP set up differently in that it offers assets protection?  

    Thank you again!

    Nathan

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    6y

    @Nathan Herber

    QRP stands for "Qualified Retirement Plan". Solo 401k is a QRP. 

    0Reply
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