Power Up Wealth podcast – Tapping Into Your Retirement Account – Episode 41 transcript:
Sharla Jessop 0:00
You’ve just found out your company is downsizing, and you’re getting laid off. Now what? This is a common scenario in the current economic landscape. I’m Sharla Jessop, President of Smedley Financial, and today my guest and colleague, Mikal Aune, will talk about the opportunity and consequences of tapping into your retirement account.
Welcome to the SFS Power Up Wealth podcast, where we provide impactful insight and expert opinions on timeless financial principles and timely investment topics, preparing you to make smarter decisions with your money.
Mikal, it’s great to have you with us today.
Mikal Aune 0:54
Thanks, Sharla.
Sharla Jessop 0:55
Mikal is a financial advisor and vice president of the wealth management team at Smedley Financial. He holds a Certified Financial Planning designation and an MBA. Mikal, if there has been a trend in 2023 so far, it’s been companies reporting layoffs. What do you want people to know about their options when facing this kind of news?
Mikal Aune 1:16
Just know that there are a lot of options. It can feel like it’s a gut punch, and you feel like you did something wrong and 1) you have to realize you haven’t done anything wrong. And a lot of times, businesses haven’t done anything wrong, either. They are facing realities that they didn’t plan for, and things change in the business environment. And so there are going to be changes in issues and things that everybody has to work through. And so keep your head up high, keep your chin up, start thinking what are the things that I really need to pay attention to? Now we’re going to talk a little bit today about the 401k. And how to tap into that if you need to. And sometimes you have to. There are other things that you have to worry about, you know, like, are you getting a severance package? How am I going to handle the severance? When do I start looking for another job? Do I have any PTO that’s going to be paid out? What about my health insurance? How does that continue? Do I get COBRA? Does it go through an exchange? Or do I need to file for unemployment? There’s so many things that you have to think about and tackle as you as you face a transition in life.
Sharla Jessop 2:21
That’s large. There’s a lot of things to consider. We focused on helping people prepare for retirement and for a successful financial future. To us, that means put money in your retirement account diligently and don’t touch it. It’s sacred don’t touch the money. But there really are times when someone might need to tap into their retirement account while they juggle all of these decisions and figure out what their future is going to be. What would you tell them?
Mikal Aune 2:46
Starting at the beginning, the reason why people don’t want to tap into retirement and why we always, always put typically recommend to not tap into it is because of the penalties associated with it. So if you’ve been socking money away in your 401k, but you’re under age 59 and a half why it’s a half I don’t know if there’s a magic number in there for some reason. But if you’re under age 59 and a half, there’s a 10% penalty if you pull money out early from your 401k. So I’ve had plenty of people come and they’re like, okay, I got laid off. I want to pay off all my debt, including my house. And like, okay, how much is that? Well, it’s about $100,000. All right, do you realize how much you’re going to have to pull out in order to pay off the $100,000 because not only do you have your ordinary income tax that’s like 22% 24%. And taking out that much money can push that tax bracket even higher. But let’s say it’s 24% plus, you have 5% state, at least in Utah, and there’s a 10% penalty on top of that, you would have to pull out over $163,000 to get $100,000 to pay off all your debts. So that’s why typically we’re like, okay, maybe some options, but you know, just pulling out a big chunk is not a great option, unless you have other ways to tap into it, and either avoid the penalty or get some money out tax-free.
Sharla Jessop 4:03
Well, does it matter how they’ve contributed because they in a 401k you can contribute before tax meaning it can be tax-deferred, or in Roth wouldn’t a Roth be tax-free access?
Mikal Aune 4:13
Yes, typically. So if you’re still working, whenever whatever you put into your Roth, that’s a contribution. You’ve already paid tax on that money, that money is yours, you can take it out, as long as you’re working for that company. As soon as you get laid off, you can no longer tap into the 401k itself to pull out the Roth contributions because you don’t have a way to pay it back through your payroll deductions. But there is a possibility to pull it out into a Roth IRA. Now, there’s some caveats here because you have to have had an existing Roth IRA that has been open for five years because there’s a five-year rule that you have to worry about, but you could potentially roll out your Roth 401k. Now granted, keep in mind if you roll out one port part of the 401k you have to roll out everything so you can’t just like Roll out the Roth, you’d also have to roll out the pre-tax that pre-tax could go to a traditional IRA. So you would roll out your whole 401k, the Roth portion would go into your existing Roth IRA. But now that it’s in the existing Roth IRA, you could tap into the contributions or the basis what you have put into it tax-free. So there’s a lot of ins and outs on that one. But it’s a good way. If you’re like, hey, I need some money. I don’t have any other way to keep myself afloat. But I’ve been putting in money that I’ve already paid tax on, let me see if there’s a way that I can get it out and get some of it out tax-free.
Sharla Jessop 5:35
What about a hardship? Wouldn’t that be considered if you’ve lost your job, you’d think on list of hardships, that’d be right up there towards the top.
Mikal Aune 5:42
It is, but you have to keep in mind too, there are hardships for your company, and then there’s hardships once you’re no longer with your company. So if you’re still working, you can go and apply for a hardship loan where you can get money out, and then you can repay it through the payroll deductions. Once that severance has happened, or once the layoff has happened, you’re no longer with the company. And so your hardships options have changed a little bit to where you can only do things like you can avoid the taxes on it, but you may be able to avoid the 10% penalty, if you use it for things like paying your health insurance premiums. Or if you have medical expenses that haven’t been or they’re unreimbursed, or to pay your federal taxes, if you’re back on taxes, you can take a distribution, and you can use it to pay taxes. Okay, and you would still have to pay your ordinary income taxes on that. But if you would at least avoid the 10% penalty,
Sharla Jessop 6:33
Talking about taxes and penalties, isn’t there a way to manage the taxes?
Mikal Aune 6:38
One thought is just if you know that you had really good income in one year. And if your income you don’t know what it’s going to be in the next year, if you could at least delay taking a distribution from your 401k and push it into the next year, then maybe your tax bracket drops because your income has dropped. And so even though you’re taking out money from the 401k, and you have a 10% penalty, maybe your tax bracket is like 12% instead of 22. And so it doesn’t really hurt you as much because your income has dropped in that following year. You do have to keep in mind that if you do get unemployment, unemployment is considered taxable income. So just factor that in.
Sharla Jessop 7:19
It’s obvious that you need to talk to an advisor, like our wealth management team, because there’s so many caveats to every single option. What if somebody’s close to retirement?
Mikal Aune 7:29
One cool thing that a lot of people don’t know about is that you can tap into your 401k early through a thing called substantially equal periodic payments, or 72t distributions. This works if you’re under 59 and a half. Okay, so let’s say somebody’s 55. And they’re like I’ve been laid off. I have a couple mil in my 401k, I think I can make it. Should I just retire and not keep looking for another job? Well, you can set up those substantially equal periodic payments. They have to go for at least five years or age 59 and a half, which whichever is longer. But if you set up those payments, you can get payments and avoid the 10% penalty. You still have your ordinary income taxes. But you can say I’m retiring at 55, I’m getting payments from my 401k. I’m comfortable, I don’t need to worry about finding another job.
Sharla Jessop 8:19
Early many, many years ago back in 2000, 2001 after the 90s when everybody’s you know, earning 15% on average on in their accounts, and they’re feeling like rock stars in their retirement accounts. And they hit a certain age, not quite retirement but lose their jobs, and not a lot of opportunities for a few years. Unemployment was quite high. We saw 72t distributions used quite a bit. Unfortunately, people didn’t realize they were locked into still taking money out of their retirement account even though they had found another job.
Mikal Aune 8:54
Yes.
Sharla Jessop 8:54
So that compounds the tax situation.
Mikal Aune 8:57
Right, because you’d be in a very high tax bracket. So if there’s a possibility that you’re going to get another job and it’s going to be a good paying job, then you don’t want to start the 72t distributions because you cannot stop them. There are large penalties if you do.
Sharla Jessop 9:10
You know what if you’re just tired of working for somebody else, what if this layoff was the straw that broke the camel’s back and you think I’m not going back to work for anybody ever again, I’m gonna work for myself. What options do they have?
Mikal Aune 9:20
For some people? This is the nudge that they needed to become an entrepreneur to start their own business and be like, hmm, is there something that I could do better? I see so many things, and I just haven’t gone out there and done it because I’ve been so busy. Well, now you have time you’re like, I really want to start up the business. So there’s another cool thing that a lot of people don’t know about. And it’s called a rollover for business startups or ROBS and there’s only a few places that do this. So you have to really get the education. There’s lots of ins and outs on this. So keep that in mind. We can’t talk about all the ins and outs. We just don’t have time today. But what it is, is you take your 401k you move it to a custodian that deals with self-directed 401ks, there’s only a handful of those around. So keep that in mind. But then you can use the value inside of the 401k to purchase like your company stock or your LLC units. And if it purchases it, so your 401k is a majority owner, typically in your new entity, but then your entity has cash that it can use to start up the business. You have to keep in mind the risk that you’re taking with it because there are challenges to starting up a new business and a lot of new businesses fail. You don’t want to short circuit your retirement because you started to want to start up a business and then it fails, and then your retirement is just gone. Keep that in mind. But just know that there is a way that you could tap into your money and it would be tax-free. Now granted, if your company grows in value, the 401k holdings would grow in value too. And they’re still mostly going to be pre-tax. So you just have to keep that in mind that just like the 401k is going to be an owner and things are going to flow back into the 401k if there are payments or anything else that are coming in from the business, and the majority of that is going to be pre tax unless you have Roth 401k. And that would be even more beautiful because a Roth is tax-free. But you already have to have money there in order to use it.
Sharla Jessop 11:14
I can see there are so many implications to think about besides all the other issues you have to consider when you have just been laid off and how you’re going to feed your family and pay your mortgage before tapping into your retirement account. There’s just some things that you need to know. What would you tell people?
Mikal Aune 11:30
One, like I said before, you know, keep your chin up, realize that it isn’t your fault. Okay, you can start opening up a new chapter of your life as you transition and find something that is better than what you had before. So just know that there are options and opportunities out there for you. If you need to tap into your 401k to help get you through it until you find the next career option, then you can tap into it. There’s different ways to do it that could help you and springboard you to a better future.
Sharla Jessop 11:58
And rely on your financial advisor to help you make those important decisions.
Mikal Aune 12:03
Always! Because there’s so many ins and outs on these opportunities that if you do one thing wrong, it can blow up on you. So make sure that you have competent advice people that really know what they’re doing that can help make sure you know all the pitfalls before you jump into something.
Sharla Jessop 12:19
Mikal, thank you so much for that valuable information.
Mikal Aune 12:21
You’re welcome, Sharla.
Shane Thomas 12:27
Thank you for joining the Power Up Wealth podcast. Smedley Financial is located at 102 S 200 E Ste 100 in Salt Lake City, UT 84111. Call us today at 800-748-4788. You can also find us on the web at Smedleyfinancial.com, Facebook, Instagram, Twitter, and LinkedIn. The views expressed are Smedley Financials and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice. Securities offered through Securities America. Inc., Member FlNRA/SIPC. Roger M. Smedley, Sharla J. Jessop, James R. Derrick, Shane P. Thomas, Mikal B. Aune, Jordan R. Hadfield, Registered Representatives. Investment Advisor Representatives of Smedley Financial Services, Inc.®. Advisory services offered through Smedley Financial Services, Inc.® Smedley Financial Services, Inc.®, and Securities America, Inc. are separate entities.
