How To Avoid These 401k and Roth IRA Mistakes – Episode 232

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[00:03] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, best-selling author, Kim D.H. Butler. Welcome to the Prosperity Podcast today. We have Kim Butler with us. Are you there, Kim? Yes, I am. Well, we are covering the topic that a lot of employees and people in the corporate world are asking. And it is this. Once they have set up the 401k with their company and they’ve put a little bit of money aside in the Roth IRA, what’s next? And maybe they’ve even set things up the wrong way. So we’re going to turn it to Kim and ask her what she would do next. Well, I really want to commend that person because the most important thing is they

[01:00] chose to save some money. So that’s a good start. And yet, unfortunately, because of the restrictions that both 401ks and Roth IRAs have, all of that money is essentially locked up till 59 and a half. Now, yes, there’s hardship loans and yes, you can withdraw your principal from Roth, et cetera. But as a general rule, that money is locked up. And so what I’m going to recommend is that they actually take a step back and maybe they’ve already done this, so I’m going to give both answers. They will want to have the foundation. What they did is they started building the house without the foundation and the foundation is cash value of whole life insurance. Yes, that boring old product that is extremely effective and efficient and yet overlooked

[01:49] because of the wrong information that is out there in the media about it. So the whole life insurance cash value should be used as their place to store emergency opportunity money. Now, maybe they’ve already got this at a savings account or a money market or a CD or something like that. That’s great. Full life insurance is a more efficient place to store emergency and opportunity money. And so they would want to learn about that. And yet, I think really your question is more on the investment side. Like, okay, maybe I already have whole life insurance or okay, I already have a savings account. I get it. figure out if that’s a better way for me to store my emergency opportunity fund. And yet, where do I go next in terms of investments?

[02:37] Is that your question? That is that’s where is what’s the next step. So my recommendation on 401k plans is to and of course, this is a podcast. So you know, this is generic information, not appropriate for absolutely everybody. But as a general rule of thumb, my recommendation on 401k plans is to fund only to the match level, MATCH. And what most people out there are hearing is that they should fund their 401ks to the max level, MAX. And I highly disagree with that because the 401k up to the match, MATCH, can be reasonably efficient. Yes, it’s in the stock market. That could be problematic. You do get that match and it is a hard thing to overlook. And yet, all of these people are putting into the max level,

[03:33] MAX, and so they’re locking all their money up till 59 and a half. They’re subjecting those dollars to future tax rates, which we have no idea what they’re going to be. And they’re really limiting their potential because it’s stock market related investments that are typically inside 401ks and Roth IRAs. And so we want to get the dollars that are between match, MATCH and max, MAX, diverted into something else. So again, if you haven’t started your foundation, then you’ll want to go the whole life route with those dollars. If you have started the foundation, maybe you add a little more to it, or you seek investments that you can control. So the fifth principle of prosperity, we have seven of them.

[04:26] You can check them out on the website. The fifth principle is control. And that’s the biggest hang up that I have with both 401ks and Roth IRAs is that you do not control that money. That technically isn’t really even yours. Because if you look at your 401k statement, it’ll say, for the benefit of your name. And the Roth is equally controlled by the government, not by you. So you want to take the dollars on the 401k that are not matched and redirect those dollars. Now, here’s one of the challenges. We’re talking monthly money here, right? Absolutely. So it’s kind of hard to take. Let’s say it’s 500 bucks. It’s kind of hard to take 500 bucks and really do much with it. And that’s why running those dollars first

[05:14] through the cash value of whole life insurance is so beneficial. Now, I want to make it clear. I’m not identifying cash value of whole life insurance as an investment. It’s not. It’s an emergency opportunity fund. And yet, the really good investments need lump sums. And so we can use our emergency opportunity fund called cash value of whole life insurance to build up a opportunity fund that will create a lump sum where we can then borrow against that and go pursue an actual investment that is going to be very safe and secure that we can fund with a lump sum and get good results with. And that’s a much better strategy than just, quote, maxing out our 401k and hoping that everything goes well.

[06:08] And so I just want to pause there. Do you think I answered the 401k part well enough before we switch to the Roth? I think so. There may be another listener question when they’re saying, OK, they have the 401k. Would it make sense to cancel it out and just put everything in? Or should they just match, as you mentioned, and take the excess? I’m really glad you clarified that additional question, because, yes, people ask that a lot. And I do not believe that you should cancel your 401k. It’s fine. Keep it there. We can work around it. There’s no point in paying that penalty as a typical guideline. Now, there’s obviously exceptions. And we can always help you with that personally. But as a typical rule of thumb, first of all, if you’re still employed,

[06:55] it’s pretty tough to do. So if you are at the employer that is providing you this 401k, you just need to stay the course. But you can reduce down to the match MATCH level. And then if you’re not employed, that’s a whole another. Sorry, clarify. If you’re not still at the employer where that 401k is, that’s a completely different discussion. We’ll pick that up on another podcast. But if you’re still employed, just stay the course. Keep the 401k going up to the match level only. And what you might do, especially as we record this late in 2017, is look at shifting some of the existing assets that are inside that 401k plan to not stock market-related choices. In other words, inside your 401k, you

[07:48] have maybe 20 different choices you can pick. Somewhere in there, there should be a cash account or a fixed account, preferably not even bonds these days, but some type of liquid account, cash account, money market, something like that. Shift your existing assets to that. And also shift where your new dollars are going to that fixed account so that if and when we do end up with a stock market crash correction, whatever you want to call it, we have those assets protected. And your 401k is not going to become a 201k overnight because of another 2008 scenario. We all suffered through that, so I know what you mean. Yeah, that wasn’t really fun. And so we can protect that. And then circling back, no, don’t cash out.

[08:35] Yes, it is just a 10% penalty plus tax. And we could argue that there might be some warrant in doing that, but there’s really no need. Stay the course. And then on the Roth IRA, the same thing I would say, don’t cash out. Just as a general rule of thumb, making a major change like that is not necessary. And it’s often not beneficial. Like just you got in there, let’s work with what you’ve got. What’s important on the Roth IRAs is that, again, that money is protected. So again, typically it’s going to be in the stock market. A lot of people I find have their Roths in cash because as we’ve identified, they’re funding monthly or annually and there’s just not that much money in there. And so there’s just not much that can be done with it.

[09:18] However, if the Roth IRA is truly a Roth, oh, we get to have additions from Emma Dogg. Little corporate mascot conversation. If the Roth IRA is truly Roth IRA and not Roth 401k connected with the employer, then we can look at some alternative investments and see if we might use that Roth IRA to invest in a place where it’s not subject to stock market. But you’ve got to have at least $25,000 to make progress there. And I find a lot of Roth IRAs are hanging out in that $6,000, $10,000 number. And to be frank, there’s just not that much can be done at that point. And they’re truly better just sitting in cash and making sure it doesn’t get cut in half. That makes sense. Now, one of the things that you talked about

[10:09] was borrowing against when you have that life insurance in place. So if a person is taking the difference of the match and the max and they’re putting it into life insurance, can you give a couple case studies of how they can borrow against it and use that money? Absolutely. So we’ve got a client in Florida that I can think of right now. And they contributed to their 401k up to the max, shrunk it back to the match, MATCH, used that difference after tax, because now you’re going to have to pay tax on that money, for about five years, and funded their cash value of life insurance with both premiums and paid up additions. And then they had an opportunity to invest in what we call a bridge loan,

[10:59] or you could just think of it as a real estate deal, whereby they took the cash value of life insurance, borrowed against it, made a down payment on a property, and that property was bought for cash flow, not for appreciation. That’s a very important point. They then used that cash flow to pay back the life insurance loan. And as we’re all well aware, a down payment on a property has to be a lump sum. You can’t do it at 500 bucks a month. So they took that money, funded the cash value of life insurance, built up that lump sum, borrowed against it, and then paid it back. That’s a beautiful strategy. And typically the borrow against rates are gonna be in the 5% zone, give or take. And of course, a good real estate deal

[11:49] should be able to earn 8, 9, 10, 11, 12%. And this property then enabled them to, once the life insurance loan was paid back, continue on with the ownership, of course, and now they can take that cash flow and either parlay that up into more savings, more capacity in their emergency opportunity fund, or they could use that money for lifestyle in their family’s situation, whichever they wanted to do. Wow, that’s really taking your return on investment to a whole nother level, where you’re taking the loan, you’re borrowing your life insurance, then you’re investing it into a cash flow property, and you’re getting, in some cases, 8, 9, 10% in excess, and you can continue to repeat that process as you build your opportunity fund.

[12:43] So that’s wonderful. Yes, it’s an example of both the sixth and the seventh principles of prosperity. So the sixth is move. We always want our dollars to be moving because it means that they’re alive and they’re doing things. And so essentially what that client did is he flowed the money through the life insurance, and that verb through is very important. It’s not to the life insurance. Of course, your emergency money is going to the life insurance, but the cash value enables you to borrow against it. So it’s through. And then the seventh principle of prosperity is multiply, and that means that $1 did the life insurance work, and then it did the real estate work, and now it comes back to the life insurance.

[13:27] And of course, when it’s inside the life insurance, it’s doing lots of jobs too because it’s providing the death benefit, and it’s important, and most of our listeners will know this, but just in case we have a new one on the podcast today, we want to remind ourselves that while we’re borrowing against cash value, the growth of that cash value is unaffected, and that is because we’re truly borrowing against it. We’re not borrowing from it. We’re not removing dollars from the account. There’s nothing magical about this. You could do the same thing with a CD at the bank. You’re borrowing against the cash value of the life insurance. Now, you could say you’re borrowing from the insurance company, that’s accurate,

[14:14] but it’s still against the cash value of the life insurance, and that enables that cash value of life insurance to continue to grow, while at the same time, the money from the insurance company is making the down payment on the property. Wow. So I think for our listeners today, as we wrap up, it’s important for them to realize if they have a 401k to scale back to the match, not the max. And as you’ve mentioned also, that if they have the 401k and the Roth IRM, probably just leave it in place, is that right? Correct, yeah, really well said. And if you’ve got questions on this, please reach out to me, I’m happy to help. And of course, we’d love to include you on our client list, but if you just have a question

[14:58] you really need it answered, we have a special email for podcast listeners, and it’s hello at partners, number four, prosperity.com. And I’m happy to answer those types of more individualized questions. Perfect, thanks so much for spending time with us today, listeners. And again, if you do have those questions, send those to Kim at hello at partnersforprosperity.com. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.