Your 401k Isn’t as Accessible as You Think (Ep. 268)

"If you're like, 'Hey, Joe, do this 401(k)' — like, okay. But if you're like, 'Okay, well, why am I doing the 401(k)? What are my goals in life? How am I making sure that my actions are aligning with where I want to go?' Those are all amazing questions, and chances are they might change how you view your actions, right? Because you're more intentional about it."

Hello, hello, and welcome back to the podcast. It is Tarisa again. I'm excited to be here with you guys today. We are going to continue the series of the top five half-truths of 401(k). Try to say that 10 times fast.

And so today we're gonna go over the third one, because if you remember, we went over management fees, the impact of taxes, and today we're gonna go over access and distribution. This is why this is really important: because if you are putting a really large chunk of money out in any environment, you should know the rules of the game. A lot of that has to do with how can I get access to this money if I need it, and how is it distributed to me when I'm ready to retire?

Because money is really just a game, it's important to know the rules of the game that you're playing. We're gonna go over these together, and again, I will preface this with: I am not a financial advisor, this is just strictly based off of my research and findings. A lot of this comes from the IRS website itself, so straight from the government. But if you have questions about this, check with your financial advisor, ask your HR plan, ask the head of HR what your plan entails, what does it mean for you specifically.

Okay, so there are two types of distributions. And essentially, you have to qualify for access either way, no matter what distribution you take.

So number one is minimum distributions. Basically what the government is saying is that, "Hey, Joe, you have to take out this money at age 73, no matter what." Even if you haven't retired, even if you don't wanna touch that money, the government doesn't care, because you've had that tax deferral up to age 73. They're ready now to collect on the taxes that you have to pay on that distribution.

I'll give you a scenario in which this doesn't necessarily work out for the person that is using it. So my mentor, his friend, is a high income earner, and he is at the age where he's required to receive a distribution, but he doesn't want to, because it essentially pushes him into a different tax bracket. If you are good at making money and you don't necessarily need to take the distribution at the time, that can push you into a tax bracket, which essentially means you pay more tax. They don't really care if you don't want to take it or not — you are required.

The second type of distribution is a hardship distribution. So again, my question is, well, what falls under that? What falls under hardship? And who determines whether or not I'm going through a hardship? Is that my plan? Is that someone else? Again, I looked into this for you guys because I'm a nerd. I like to have the specifics. I like to have the details.

This can include medical care expenses, which is good. Purchasing a primary residence, also great. This does not include making your mortgage payments. It can help you by preventing eviction or foreclosure. It can cover funeral expenses or primary residence repairs. So if you have anything that falls outside of that, it does not qualify as an exception to not pay the 10% penalty.

This is just one way that you can have access to your 401(k) plan, is in the form of distribution. Now, the other thing is you can actually borrow against your 401(k). There's a loan provision in your 401(k), similar to a policy, I guess, but again, there's a little bit more red tape, right? Because we're dealing with a plan that involves the government, so there's just more nuance to it.

So you can borrow money from your 401(k) up to $50,000 or half of your vested balance, whichever is greater. For example, if you have $80,000 in your 401(k) plan, you can borrow out $40,000. If you have over $120,000 in your 401(k) plan, then that means you can borrow out 50. You can't borrow more than that.

Now, let's get into the rules, because the rules are important. Your loan has to be repaid within five years, and if you leave with an outstanding loan — like either you quit or you're fired or you're laid off — they can call that full note due, meaning if you leave tomorrow, they can ask for that money back in your plan. Usually it's between 60 to 90 days of separation, or by the tax filing deadline or sooner.

Again, I like to ask, "Well, what then?" If you borrow out that money and one of those things does happen to you — let's say you're fired, and you can't repay it by the plan's deadline and they're asking for the full amount of balance — essentially what happens is they classify that then as a distribution.

Your plan reduces by the unpaid amount, and then you have separate taxes kicking in. You take the distribution, they classify it as a distribution, you have to pay the penalty of 10%, unless it is an exception that we just covered earlier. So you have to pay the 10% penalty if you're under the age of 59 and a half.

You still have the loan, though. That's a thing that I just learned as well. You still have the loan even if you write it off as a distribution. So you're paying income tax, you're paying the 10% penalty, and then you still have the loan to repay. All the while that loan is gathering interest, essentially for a nonpayment. The loan just doesn't go away because you decided to not pay it, if that makes sense. And I guess that's true of any loan, right? You can't just ignore the fact that you have a loan and that you're not paying it — or you can, but I don't know how well that's gonna go for you.

This is, I think, what is super interesting and fun to go over: well, what happens to the money that I've borrowed out of my 401(k) plan? And this is, I think, a really big difference when you're kind of thinking about the best place to store money, because it is similar to the person that is paying cash and interrupting the compounding of their money.

You're paying opportunity costs, and Nelson talks about this a lot. And this is why I love Infinite Banking so much, because you don't have the opportunity cost payment that you do if you're paying cash or financing. You have the potential to earn on that money as long as you live, and the death benefit goes income tax-free to your beneficiaries.

In the 401(k) plan specifically, if you take a loan, if you borrow money out from your 401(k) plan, that money is no longer earning — because you've transferred that money to a different environment. Essentially, you are paying opportunity costs because you're still interrupting the earning potential of those dollars.

And this doesn't happen inside of a policy, because you're not actually taking the money out of the policy. A lot of people get this confused, where they're like, "Okay, well, how can I earn money and still use my money?" You're not actually using your money, you're using the life insurance company's money, and you are paying them a rate of interest in order to not interrupt the earning potential of your dollars. And that might seem like such a small, minor detail, but over the years, not interrupting compound interest is so incredible.

This is huge. The opportunity cost — not earning on the amount that you borrowed in a 401(k). You are earning uninterrupted compound interest on the amount that you borrowed in your policy. Just a loan — that's huge.

The other question is, well, what happens after you pass? We've kind of followed this trajectory to: okay, here's how the distributions work, here's how I can access it, here are the qualifying events that I have to make sure fit into this box for me to access it. Then what happens after you're gone? How is it handled with the beneficiaries?

Every dollar withdrawn from an inherited traditional 401(k) is taxed as ordinary income in the year that you receive it. Essentially, what that means is your beneficiary is still going to pay income tax on the withdrawal. There is a good caveat, though, which is that your beneficiaries are exempt from the 10% withdrawal penalty. At that point, they can elect to roll it into a different account or start taking distributions.

Let's dive into this a little bit more. We're going over access and distribution, so let's just kind of recap what we've talked about. Your 401(k) is limited by rules and restrictions, some that you might be aware of and some that you're not, right? I'm doing this series because I think it's important that you know the rules and restrictions of the plan that you're involved in.

Number two is the taxes are unknown, right? We have no idea what the tax rate is going to be in the future, and that depends a lot on who's in office, what are the policies that are going on there. Regardless of what your political affiliation is, taxes is something that everyone is going to have to pay at some point. And if you look at our government spending now, some people call it a tax on young people. It's like, we are going to be paying that credit card bill essentially later on.

The other thing is that management fees eat into the growth. So what that means is when you're interrupting the growth of your money, it's going to erode your future potential wealth.

And you have to qualify for the use of money in order to not be penalized for using it earlier. So let's say you wanted to buy an investment property and not your primary, or let's say you wanted to buy a business instead of buying your primary residence. You are restricted in the use of your money. And I think that is such a really big thing to think about, because if you're restricted in the use of your money while you're young and healthy and have all these things going on, how many opportunities are you missing out on because that stuff is locked away?

I'm not saying that it's bad to save for retirement. I am saying that there are implications in putting your money in places where you don't have access to it, or if you have to ask permission.

The other thing is growth is unpredictable. So the next thing that we're gonna go over in the next podcast — so stay tuned — is that we are sold on this 8% average rate of return, but if you look at actual account balances, they don't work on averages, right? Because let's say you have growth of 12% the next year, and then the following year you lose 20%, or maybe even 50. In 2008, a lot of people saw that happen. And the implication of it not being an average is that if you are trying to retire on a down year, you have taken away so much earning potential because of that loss.

My question to you is, are you okay with that uncertainty? And some people are. And if you're not — if you're like, "Hey, I can't afford to lose half of my account balance, or 20% even, when I'm trying to retire" — then again, I would question: is this action of you putting a lot of savings in your 401(k) really going to get you to where you wanna be? Is it going to allow you to capitalize on opportunities? Is it going to allow you to invest in your own education?

So the growth is unpredictable. Not an average rate of return. There's a huge difference between average and actual. And a lot of people don't know that you can have a positive average rate of return and still lose money. It's kind of like smoke and mirrors.

What I encourage people to do is check to see how much you've contributed, how much your employer has contributed, and how much you have access to in any given year, because that will tell you your real rate of return. It's just kind of a blanket way to say, "Hey, ideally, and based off of market performance, if you take the average of all of these years, you'll still earn an 8% rate of return." However, if you're the person that was trying to retire in 2008 and you lost half of your account balance, you're not caring about averages at that time, because you're like, I've put so much time and money into this thing and it just got reduced by half.

I mean, people really lived through this, and I think it's important that you know it doesn't just wash out that way. If you're retiring and up, you're fantastic. But for some people, that's not something you can fully control, is what I'm getting at.

Okay, now let's go over to the whole life policy. I always make a joke that whole life is unsexy. But it does what you need it to do, and that is what is so attractive about it. It's kind of like the tortoise and the hare. Everyone's looking at that Ferrari over there, but the tortoise is just chugging away slowly, and surely they're gonna get to that destination safely.

The whole life policy has guaranteed growth. You're contractually guaranteed, in any given year, how much you'll have access to and how much death benefit you have. Contractual.

So a lot of people are like, "Okay, well, what if?" And I think that's a really good question, because what you're doing is you're mitigating risk, right? Even still, if you're trying to figure out how much premium do I need to pay, or how much premium can I comfortably pay, you need to ask yourself the what-if questions.

I kind of phrase it like this. If you knew that you could buy a business and you could guarantee the performance of that business in 10 years, in 20 years, in 30 years, in 40 years, how comfortable would you be with that decision? If you could guarantee it — and that is essentially what's happening inside of the policy, is that growth is guaranteed. If you're paying your scheduled premium, that growth is guaranteed to you. So it doesn't matter what the market's doing. It doesn't matter who's in office. You can just safely know that that's what's going to be in your policy to have access to.

The other thing is that it is an income tax-free death benefit. The really cool thing about these policies is that it's kind of like the rich man's Roth. You are taking that money off of the IRS radar indefinitely, if you do it right — because if you're putting that money in a policy, and then your beneficiary receives an income tax-free death benefit, and let's say they start policies after that, all of that money is not being touched by the government. Which I think is so beautiful, especially because with the rate of government spending now, who knows what the tax rate is going to be.

And I will preface this with: unless it becomes a MEC, which is really hard to do. So a lot of people ask me that question too — "Well, what if it becomes a MEC? How do I avoid that?" This actually happened to one of my clients. They were overfunding their policy, they were putting more paid-up additions in, and they put in, I think, $100 too much. And essentially the life insurance company was just like, "Hey, Tarisa, this client paid more than they needed to. It's become a MEC. Would you like us to refund their $111?" I was like, "Yes, please do that." So it's really hard to MEC a policy on purpose or on accident.

Your expenses are fixed, included in the premium. So a lot of people ask that: "Okay, well, what are my expenses? Is there a management fee?" It's like, no, everything is bundled up inside of your life insurance policy in the premium that you're paying, so it's not going to go up. And that is specific to whole life, because some policies like IULs or ULs, those expenses go up over time. They're not fixed, right? So someone can always pull that lever and say, "Hey, our company didn't do as great as we anticipated, so what we're going to do is increase this cost of insurance." And then that is reflected on the consumer, and they'll say, "Hey, Joe, your IUL needs more premium to prop up that same amount of death benefit that you're used to."

And this is a huge one. The only thing that impacts how much you can access in your life insurance policy that's structured for Infinite Banking is how much you've put into it. Unlike a 401(k), where you're kind of inviting some kind of risky business in there, because it's based off of market performance, which you don't have full control over. You do have full control over how much premium you've put in and how much access you want to have to those dollars in order to not interrupt them.

My goal of this series is to shed light on the rules and restrictions, or the 401(k) half-truths, but also to give you reassurance that even though whole life insurance is not an investment, it is one of the best places to store your money and to have access to it.

I think we blindly put money in places because that's what we're taught to do, and I want to encourage everyone that is listening to ask yourself better questions. Because I think that when you ask yourself a better question, you typically get a better answer, and it's usually better than someone just telling you what to do, right?

If you're like, "Hey, Joe, do this 401(k)" — like, okay. But if you're like, "Okay, well, why am I doing the 401(k)? What are my goals in life? How am I making sure that my actions are aligning with where I want to go?" Those are all amazing questions, and chances are they might change how you view your actions, right? Because you're more intentional about it.

All that to say — I'll get off my soapbox here — thank you for listening to part three, and next week I will have part four. So we will go over how these things actually grow and what the implications are to that growth being unpredictable.

If you haven't made an appointment, or you have a lot of questions, please book an appointment with me, Mary Jo or John. We are here to help answer the questions that you have and to give you guys specific strategies that work for your current financial situation and where you want to go. With that being said, I hope you all have a beautiful rest of the week, and I look forward to seeing you soon, or talking to you soon. All right. Bye.