Can I take Hardship Withdrawals from my 401k?

10 09 2013

Jonathan N. Castle, MSFS, CFP

Jonathan N. Castle, MSFS, CFP

We recently had a question from a client about taking hardship withdrawals from his retirement plan. Essentially, the question was – what are they, and how do I do it? So, here is the answer we gave:

First, if you are past age 55, and are NO LONGER working for your employer – AND you have not taken the 401k and rolled it into an IRA – then you can make withdrawals from that account without the normal 10% early withdrawal penalty that typically accompanies these accounts. This is a special rule for qualified retirement plans and does not apply to IRA’s. In fact, if you roll the money to an IRA, you lose this provision and have to wait until age 59 and 1/2.

First – you must know that employers are not REQUIRED to offer hardship withdrawals – but usually they do because the plans are often “turnkey” and this feature is built in to turnkey plans. So, if you are still employed and need money from your employer retirement plan – then the simplest answer is that each plan usually has a feature to accomplish this. In many plans, you go onto the plan website, and look for “loans or withdrawals” and merely follow the procedure. If your employer plan does not have a website, or the website does is not set up to facilitate these online, then you probably have to complete a form with your HR department and/or the plan sponsor. You must certify that the Hardship withdrawal is for a purpose that falls within the allowable rules:

To buy a primary residence
To prevent foreclosure of eviction from your home
To pay college tuition for yourself or for a dependent
To pay un-reimbursed medical expenses for yourself or a dependent

Now there are also “exceptions” that do not fall into the hardship withdrawal category. They are literally as they sound – “exceptions” to the 10% penalty:

Medical debt for expenses that exceed 7.5% of your AGI
A court order for alimony or child support
You set up “substantially equal payments” for your life expectancy.

This last one – substantially equal payments – apply to IRA’s too, and are known as 72t distributions. Do not try to set this up yourself, consult with a CPA or a CFP because they are complex and the penalty for messing it up is quite harsh.

I hope this gets you onto the right path. Good luck with the obstacles you are facing!

Jon Castle

This blog is for informational purposes only. This is neither an offer to purchase nor sell any securities. All investing involves the potential of loss – including invested principal. Indices quoted are general barometers of security price movement. You cannot invest directly in an index. All information is obtained from sources deemed reliable but not guaranteed. Past performance is not a guarantee of future performance. No tax or legal advice is given nor intended.

Investment advisory services provided by Paragon Wealth Strategies, LLC, a registered investment advisor.

10245 Centurion Pkwy. N. Ste 105, Jacksonville FL 32256 (904) 861-0093

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements


Market’s Long Overdue Correction Seems to Be Starting

8 04 2013

Jonathan N. Castle, CFP®, ChFC®

Jonathan N. Castle, CFP®, ChFC®

I thought I would take just a moment to let everyone know that we have been watching the market closely. It looks like the long upward sprint the market has taken over the last 4 months might be coming to a pause.

This is not unusual at all; billions of dollars have been fed into the capital markets over the last 4 months as the veil of uncertainly about taxes and fiscal policy has been lifted. Pension funds and individual investors have flooded the stock markets and stock mutual funds with more dollars this past quarter than we’ve seen in a long, long time. Wall Street’s traders have seen their target prices for stocks met, exceeded, and exceeded again. In general, the economic data we’ve see reported has been mostly positive, with just enough bad news to remind us that the stock market still has its dangers, but not enough to get investors worried that another recession is around the corner.

So, with the information we have at present, it looks like we are in for a regular, run-of-the-mill correction of about 3 to 7%. This happens, on average, 3 times per year, and is the normal breathing of a healthy and functioning market.

It is important to keep in mind that large, painful, and excessively long bear markets typically occur only during times of great economic upset (Great Depression, Great Recession, Tech Bubble Burst, Oil Embargo). We are monitoring all of our indicators and have far better warning systems in place than existed in 2007 and 2008, and expect to be able to sidestep a great deal of the damage that those “Perfect Storms” tend to dish out. At this time, Recession Alert(TM) places the odds of the United States economy entering a recession within the next 6 months at only 6.4% – indicating that the stock market remains the best place to be for investors trying to stay ahead of taxes and beat inflation.

However, unexpected or “surprise” events can turn a normal 5% correction into an abrupt harsh 20% correction. This occurs every 3-4 years, on average. Good examples are the stock market “crash” of 1987, the breakout of Desert Storm, minor recessions, the downgrading of the US debt in 2011, and other geopolitical occurrences. Currently, we have two primary concerns that would fall into this category – the prospective bailout of Cyprus (and the EU issues that seem to never end), and the possibility of Kim Jong-Un actually engaging in real military conflict for no apparent reason other than to appear as a strong leader to his people.

The risk of military conflict does not lie in Korea’s ability to hurt the US; that risk is minimal from a military confrontation perspective. While the North enjoys a huge advantage over the South in artillery abilities, those abilities would likely be quickly eradicated by the overwhelming air superiority the US and the South enjoys. The real risk lies in the possibility of China, South Korea, or Japan entering any such the conflict and creating massive instability in the Far East. I believe that China would likely rather see peace in the region, but so far, they have taken a wait-and-see approach.

Whatever happens, we will remain vigilant and observe events as they develop. Ultimately, I believe that normal market functions will continue and am very optimistic about some of the developments we see occurring within our economy – especially in the areas of energy production, rail, manufacturing, home-building, and electronic medical records. I feel it is likely that the decade-long “Secular Bear Market” we have been mired in for the last several years is approaching an end, and that now is a great time to be a long-term investor! However, it remains important to make sure that investors are aware of their risk tolerances – and that portfolios are constructed properly in order to weather those occasional unexpected thunderstorm that can blow in rapidly and give us an uncomfortable bump now and then.

S&P500 1 Year Chart

S&P500 1 Year Chart

Jon Castle

This blog is for informational purposes only. This is neither an offer to purchase nor sell any securities. All investing involves the potential of loss – including invested principal. Indices quoted are general barometers of security price movement. You cannot invest directly in an index. All information is obtained from sources deemed reliable but not guaranteed. Past performance is not a guarantee of future performance. No tax or legal advice is given nor intended.

Investment advisory services provided by Paragon Wealth Strategies, LLC, a registered investment advisor.

10245 Centurion Pkwy. N. Ste 105, Jacksonville FL 32256 (904) 861-0093

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements

Stock Market at a 4-year High… Again…

23 08 2012

While it has been an unusually long pause between market updates this time, I can assure you that we were not asleep at the wheel. In this instance, no news was good news, as the stock market has maintained its generally upward trend for the past several months with only moderate volatility for us to endure.

As of this writing, the United States stock market is approaching the high of 13279 on the DOW and 1419 on the S&P500 that it had previously reached on May 1st of this year, before the 10% correction that we went through during June and July. Since then, we have had generally uninteresting economic news on the domestic front, no real political unrest that has given us pause, and the Europeans continue to struggle through massive debt issues and one of the worst recessions that region of the world has had to face in several decades.

It can be easy to fall into the trap of thinking that “something good” must actually happen for the stock markets to go up. This is actually not the case. Given the fact that bond markets have gone up continually over the last several years, the current prices of bonds are so high, that most investors have begun to realize that future returns of the bond market are likely to be disappointing. We are beginning to see a shift of capital from what is historically an asset of moderate risk and return (bonds) to an asset class that historically has been riskier – but is currently acknowledged to be undervalued (stocks – especially blue chips).

As a result – nothing spectacular is happening in the economy to move us measurably forward, but as money shifts from bonds to stocks (or from sideline cash to stocks) – the price of stocks will tend to move up simply as a result of supply and demand. In other words – beause more and more investors are dissatisfied with the expected returns from bonds in the forseeable future – stocks seem like a more attractive alternative, especially for long-term investors. The current owners of the stocks must be convinced to sell them – and this “convincing” is done by investors paying higher and higher prices for the stocks over time.

Approaching a new or previous high is not without danger, however. Those who have invested for a while also understand that when the market approaches a previous high mark, it may fail to break through – almost as if an invisible lid has been placed upon the market itself. Sometimes, even in bull markets, the market must pull back and “take a new run” at the “lid” to break through. Currently the market does not have a great deal of momentum; while investors are buying stocks, they are not doing so with enough gusto or wild abandon for us to be convinced that a breakthrough will occur. So… a potential correction may be in store for us.

As we have mentioned before, we are of the belief that the stock market will likely remain in a “trading range” for several years – with a slight slant to the upside (just enough to make investing worthwhile, I suspect) but not a roaring bull market that we enjoyed after the last recession. Instead, we are likely to enjoy several months of upmarkets, followed by several months of downmarkets… squeaking out 7 to 8% returns on an annualized basis, and paying for it with a good bit of volatility and lack of market direction. Dividends will likely play a significant role in creating portfolio growth. We have adjusted portfolios to try to maximize investor returns (within risk tolerance) for this scenario, and continue to admonish patience.

Most experts believe that we are unlikely to see any real economic or fiscal news between now and the election. While it is possible that world events may cause unrest, or that some good news may come out of Europe that bolsters markets for a while, in general it seems that most institutional investors are in a “wait and see” mood. Market movements, however, can give some insight into likely election results. A strong stock market during an election year has historically increased Presidential approval ratings and would likely increase the chance of the current President being reelected. If, on the other hand, the market should falter between now and November, incumbent approval ratings are likely to decline, thus increasing the odds of the Romney/Ryan ticket being successful on election day.

Jon Castle

This blog is for informational purposes only.  This is neither an offer to purchase nor sell any securities.  All investing involves the potential of loss – including invested principal.  Indices quoted are general barometers of security price movement.  You cannot invest directly in an index.  All information is obtained from sources deemed reliable but not guaranteed.  Past performance is not a guarantee of future performance.  No tax or legal advice is given nor intended.

Investment advisory services provided by Paragon Wealth Strategies, LLC, a registered investment advisor.

10245 Centurion Pkwy. N. Ste 105, Jacksonville FL 32256   (904) 861-0093  Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements

A Financial Planner’s Favorite Question: How Long are you Going to Live?

8 11 2011

by Michelle Ash, CFP®, CDFA™

Any financial planner who’s been helping clients plan for, or live, in retirement will tell you that a discussion on longevity can be an interesting conversation. There is no topic which has caused as many clients to outright laugh in my face when I tell them our standard planning assumptions as this one. You see, a financial planner’s job would be quite easy – an exercise in mathematical computations alone – if only a client could reliably provide one critical piece of information: how long they are going to live. Sometimes I joke and ask my clients to look into their “personal crystal ball” and tell me what they see there in regards to their own longevity. In response, sometimes they squirm, sometimes they get real quiet, other times they won’t even give me a straight answer. It seems the idea of talking about this critical piece of information – how long we’ll live – or its inverse – when we might die – can be quite the taboo subject.

At times people comment that “young people” – a term that’s always a relative description, of course, don’t have difficulty talking about this subject because the young believe they are invincible, thinking they’re never going to die. I have had this comment said to me by 60’s-something clients a few times as well. Perhaps it would be helpful to explain my outlook on this topic, so my attitude won’t seem cavalier, ignorant, or insensitive.

At the age of 38, I have only one grandparent left. The first died at age 52, a few years before I was even born. The other two both passed at their age of 65; I was about age 16 at the time. All three of them died from “the big C”, or Cancer, for those of you not acquainted with the term. I have an aunt and an uncle (one on each side of the family) who died in their 50’s also, from the big C as well. My remaining grandmother is going strong at age 81, showing signs of being around for years to come. She ballroom dances competitively, just retired (for the third or fourth time) last month, and is someone whom I’ve long told friends has more energy than two of me – a feat I can’t fathom since she only sleeps 3-4 hours per night. She is the role model I aspire to and I hope I’ll be blessed with her presence for a long time to come. Despite what I sometimes think of as “bad genes”, my parents, too, are thankfully quite healthy. They are conscientious of being so in their lifestyle choices, which I have long believed helps them overcome their own parental genetic history.

But given the grandparent longevity, or lack thereof, and given the fact that I personally have a chronic illness I was diagnosed with two years ago which will be with me the rest of my life, I unfortunately cannot claim to be one of those people with expectations to live to 100. I haven’t ruled it out, believe me; I am going to try, especially since my condition isn’t one that usually leads to significant implications on mortality. However, I think much in the way that clients in their 60’s sometimes realize there might statistically be only 20 or so years ahead of them, I too have to factor in that, at least based on three of my direct lineal relations, I may have way more time behind me than in front of me.

So from that perspective I stare, head on, with clients, into the reflecting pool of longevity, realizing one absolute: that none of us can escape the eventual fate of having a finite longevity.

How can an individual doing retirement planning think about the issue of longevity? What factors should they consider, and once they do, how should they use that information? What are the impacts longevity – good or bad – plays on the retirement planning? These are the questions we must discuss when considering this topic.

Longevity Factors to Consider

When it comes to factors to consider in deciding a longevity assumption, there are three major items that come to mind:

1) Family history
2) General statistics
3) Personal lifestyle choices

When I talk with clients, we generally talk through these three items. I’ll ask them how long people in their families tend to live. The answers range widely: some people will say no one’s ever lived beyond the age of 75. Others will tell me they’ve got four or five immediate relatives at or near age 100. Many will tell me one parent’s side of the family lived long lives, and the other side lived short or average lifespans. Only when the answer is at either extreme does it really provide any clear planning decision.

Next, we discuss general statistics. In the United States, at present, a 65-year-old man can expect to live to age 82.1; a 65-year-old woman to age 85.(1)   However, ethnicity, race, and country of origin do play roles in this discussion. World-wide, the United States is 36th in terms of life expectancy, with an average life expectancy from birth (not gender specific) of age 78.3. By comparison, the Japanese have the longest longevity, with average non-gender-specific longevity from birth of age 82.6 – more than four years greater than the average American. Countries including Australia, Canada, and the UK are all ahead of the U.S. on the longevity scale.(2) Regarding race, in the United States the average Asian-American has the longest life expectancy at 84.9 years. After that, the average Caucasian has a life expectancy of 77.9 years, the average African-American 72.9 years, and a Native American’s averages 72.7 years. This is a span of more than twelve years’ difference between the various racial groups.(3)

But beyond statistics and even family history, one’s personal lifestyle choices likely have a tremendous influence on longevity. Do you regularly jump out of airplanes and race motorcycles without a helmet, or are you a person who prefers a safer, less adventurous lifestyle? How’s your diet and nutritional intake? Do you get regular exercise? Do you see your dentist and doctor regularly? Do you manage your stress? We could spend hours and pages on these items and each of their likely impacts on our life and longevity.

But do those theories always prove to be true? We all occasionally hear about a little old man who lived to age 104 who smoke, drank, and gambled all his life. Sometimes, the crystal ball is fuzzy and you just never know when the end will be.

How to use Longevity Considerations in Retirement Planning

After exploring issues of family longevity, statistics, and personal lifestyle with a client, I like for us to decide together what longevity they feel is realistic to use. As planners, we start with a baseline assumption of age 95, adjusting upwards for those clients whose families demonstrate a proclivity for age, or those clients who want to assume a longer age as a safeguard. But, for those clients who would prefer to use a shorter longevity, I always caution them that doing so, and then living “too long”, could cause undesirable consequences.

You see, here’s the importance of longevity in retirement planning: the longer you live, the more money you are going to need because of the compounding effects of inflation on expenses over the long term. Here’s a simple illustration of what I mean:

Longevity to age 95 versus Longevity to age 85:

In the fact pattern illustrated above, keeping all other facts, figures, and assumptions the same, the top chart – longevity to age 95, shows the likelihood of a significant spend-down in assets. The bottom chart, longevity to age 85, on the other hand, seems to indicate that the client is never dipping into principal. In fact, their portfolio would be projected to grow and be larger at death than it is at present.

Now, extrapolate that into trying to advise a client on how to spend their money in retirement and invest: with the forecast at the top (to age 95), I would be counseling my client to be prudent with their expenditures over their lifetime, realizing that investment returns are just as unpredictable as longevity. What if the client on the left has unforeseen increases in costs due to medical events, or the need for long term care? If these aren’t included in our current planning, running out of money might well be within the realm of possibilities.

Advising the client with the projection at the bottom (longevity to age 85), however, might cause an advisor to tell the client they can likely spend more money than they currently do, should consider gifting strategies over their lifetime, endeavor tax and estate planning techniques that will mitigate the likely increase in taxes that is coming from this future forecast of an ever-growing portfolio, or invest much more conservatively because it looks like they’ll have plenty of money no matter how long they live.

See the drastically different advice that comes out of one seemingly small assumption?

How to Decide Which Assumption to Use

Generally, the only clients I’ve met who can provide me their longevity with reasonable predictability are those whose longevity is relatively short, often from some terminal illness now beyond their control. For everyone else, sooner or later, a choice of assumption must eventually be made. I tend to see three schools of thought clients use to decide:

Conservative approach: Use a long life expectancy, even beyond what might be reasonable for them personally, because not running out of money is more important to them than the financial flexibility a shorter life expectancy might provide.

Moderate approach: Assume an average, or even slightly longer than average, life expectancy, to account for the majority of likely longevity implications. Act according to those results. If money runs out, have a contingency plan (ie- the kids will have to take care of me), but have an expectation that the contingency probably isn’t necessary.

Aggressive approach: Some clients want to spend it all. Sometimes I hear people say, “I want my last check to bounce.” They may request the most aggressive (short) life expectancy assumptions, even if their family history and personal circumstances would indicate otherwise, because their intent is to spend down assets. Sometimes they have a backup plan if there’s more life than money; other times they think they’ll figure it out if and when they get there. Personally, as a planner, I like this method the least. I encourage against it and I document like crazy as a future CYA measure in case the worst does come to pass.

But ultimately, which approach will prove right? Truly only time will tell. Until it does, here are three mitigating suggestions:

Mitigating Suggestions

1) Use different longevity assumptions and see what the planning outcomes are for each. This approach can be helpful if you’re really not sure which assumption to use. At least then you can know the results and begin to get a sense of different outcomes. Doing so might also help you with other actions you need to take, regardless of deciding a specific longevity. For example, if you want to invest really conservatively in retirement for fear of market volatility, but doing so means you only have enough money to age 70, you may instead want to consider working a bit longer so that you can give yourself the freedom to invest the way you are comfortable. In this example you don’t need to decide a longevity, because the planning assumptions you are using make the other decisions for you.

2) Use a blended spending strategy in retirement. People who aren’t retired often see retirement as this one large life event: you retire and that’s it. Retirees will tell you that retirement is often a more complex life event. In fact, today four stages to retirement are recognized:

a. Newly retired (first 6 months): discovering who you are without your work world identity
b. Recently retired (6-24 months): exploring all the new hobbies and ideas you may want to pursue as you enjoy retirement
c. Retired (2 years – 20 years): Life as a retiree has developed a routine; enjoyment of the lifestyle chosen occurs in this phase
d. Late Retirement, Elder Issues: Life slows down considerably as age and illness related issues often occur

As financial advisors, we often see that clients might desire to spend a greater amount of money when they first retire as they are exploring the newness of retirement. Once the explorations have occurred and a routine develops, expenditures may slow down until later when elder issues enter the picture and raise costs again. A financial plan can account for these different spending levels, if planned in enough detail.

3) Revisit your longevity assumption periodically. This is actually a recommendation I’d make no matter what the planning scope is. Planning – financial or otherwise – inherently requires assumptions. Assumptions are, by their very nature, just guesses and are sometimes wrong. Revisiting the longevity assumption you make over time can be very helpful. If a client chose to use a short life expectancy upon initially retiring, but now realizes there might be many more years ahead, they may be able to alter course to continue a comfortable retirement. If a client chose a long life expectancy but has developed a health issue that changes that forecast, they might decide it’s time to accelerate spending or gifting their assets.

Choosing one’s longevity assumption can be interesting, thought-provoking, or even sometimes scary. In my mind, though, there’s only one thing scarier – making no assumption at all, having no plan at all, and then hoping the results are ones you can live with.



1 National Vital Statistics Report, Volume 56, Number 9, December 28, 2007 U.S. Department of Health and Human Services, Center for Disease Control and Prevention (CDC). Year 2004 data.

2 Wikipedia:

3 “Health News: Race, Income, Geography Influences US Life Expectancy”, by Tom Harrison, 9/12/06

This blog article does not constitute legal, tax, or personal financial advice.  Please consult your own financial professional for personal, specific information.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.

Should I Still Invest in a Crappy Economy?

20 09 2011

By Jon Castle, CFP®, ChFC®

It does not seem to matter who the potential investor is – whether they are already retired, are nearing retirement, or are a younger person with quite a bit of time until retirement… the question is often the same.  With interest rates being so low… with the markets unpredictible and volatile – what should I do?  The questions aren’t even really so straight forward as, “why should I invest my money now,” or “should I pay off debt first,” or even any of the other questions that, as a financial advisor for more than 15 years now, I’m used to getting.  The questions I am hearing now seem to have taken on the tone of confusion, despair, and a lack of direction, versus the questions I used to get such as “how should I invest,” or”what type of account – a Roth or a traditional IRA – should I have?”

Yesterday, when talking to a rather successful, nearly retired client on the telephone, she mentioned that she feels that she always has to take two steps backward for every three steps forward, and ideally, she would rather not see her account fluctuate at all once she retires next year.  “Isn’t there just something we can do with our money to earn a steady 6-8% or so with no risk?”  Unfortunately, the answer is NO.  While there might be many product salesmen out there who will try to convince you otherwise – the answer is still NO.   If there were -then all the institutions and large organizations in the world, who spend millions and millions of dollars trying to find or design such assets would have already found them.  A classic example of people and institutions trying to get outsized returns with no perceived risk is the recent mortgage debacle, and we saw how that turned out.

So – back to the original question – With the Economy on shaky footing (to say the least) and with the markets being… unusually volatile, to put it lightly – what should I do?

To answer this question, I had to turn to the history books, tenured academic research, and even some new research – but I think I found the answer.  Do EXACTLY what you have been told to do throughout the years.  Live below your means – save a portion of your income (assuming you are working and saving for retirement) and invest in a fully diversified portfolio designed specifically for your risk tolerance.  In fact – it is having the GUTS to invest during times like these that separate the winners from the… folks who wish they had as much money as the winners.

Last year, Dimensional Fund Advisors tapped into the database held at the Center for Research in Security Prices (CRSP) at the University of Chicago – the nexus of more Nobel-Prize winning research in economics than any other institution on the planet – to identify IF there was a direct correlation between a poor economy (as defined by low GDP) and poor investor returns.  In other words – SHOULD I STILL INVEST IN A CRAPPY ECONOMY?”

The Dimensional Study started by taking all of the world’s developed economies, examining their annual GDP growth from 1971 – 2008, and dividing them into two groups – High Growth, or Low Growth – for each year.  Clearly, much of what we hear on the news is about GDP growth – is our economy growing or not?  The higher the economic growth, the better – as this means reductions in unemployment, increases in personal wages, and, generally, a feeling of well-being, versus the cloud of general malaise that seems to have decended upon the world as of late.

Once the economies were divided into High Growth and Low Growth – the performance of their stock market indices was compared to their GDP Growth.  The question:  Does a poor economy (low GDP Growth) accurately predict poor investor returns?  The question was not – can an investor perform poorly during low-growth times (of course, we know that is possible) – but is there a clear and determinable correlation between a bad economy and a bad investor experience?

Oddly enough – the answer is NO.

                              AVG GDP                      AVG RETURN              Risk (Std Dev)

High Growth               0.92                             12.90%                          23.07

Low Growth               -4.02                            13.52%                          23.04

The data for Emerging Markets was similar, but quite honestly, the data for Emerging Markets only went back to 2001, and I felt this was just too short a time period to draw any reasonable conclusions.

When I first saw the data, I thought… well… this might be a sales pitch just to keep investors invested… we are still looking back only as far as 1971.  What about other periods of lousy growth?  And what about for the US in particular?  I wanted to check the data myself.  So, I delved into the CRSP database myself, using the French and Fama indices that go back as far as 1926, and to the Bureau of Economic Analysis (BEA.GOV) and compared hypothetical investor returns to the GDP growth (or lack thereof) during the 1970’s and during the Great Depression.

One particular period of interest to me was the years from 1972 to 1982.  Yes, this was after 1971, but I wanted to look at it further and in more depth from a portfolio manager perspective instead of just looking at the stock market.  How did it feel?  Remember the oil embargo?  Our defeat in Vietnam? The Cold War?  Carter’s “Misery Index?”  Double Digit Inflation?  During this period of time, the average GDP Growth was only 2.7% – well below the historical average of 3.4%.

The second period of interest was the period of the Great Depression.  Now the Great Depression itself lasted from 1929 to 1941 – but for this particular exercise, I wanted to look at the period starting about 2 and a half years AFTER the crash – starting with the summer of 1932 until the attack on Pearl Harbor, or December 1941 – the long, grinding years of the Depression.  During that period of time, our average GDP Growth was only 2.0% – the longest and weakest period of below-average growth on record for the United States.

My question was – how could today’s investors, using a properly designed, diversified portfolio,  have done during that time?  Were these two periods of time – arguably the worst periods (economically) in the past hundred years – a bad time to be invested?

Assume a relatively simple, domestic portfolio:  T-Bills (15%), 5-Year Treasuries (15%), US Large Stocks (11%), US Large Value, or underpriced, dividend paying stocks (21%), US Small Value Stocks (18%), US Small Stocks (10%), and Very Small, or Micro-Cap Stocks (10%).

Looking at the indices only (remember – there were VERY few mutual funds at the time of the Depression, and certainly no ETF’s,) we can get an idea of how an investor might have done.  The following numbers do NOT account for any fees, commissions, taxes, etc – but we can still draw conclusions.

From the period of 1932 – 1941, the above, simple, diversified portfolio (indices only) would have achieved an AVERAGE ANNUAL return of… wait for it… 19.29%!!  In fact one dollar invested as described above in the summer of 1932 would have grown to about $4.50 by December of 1941.  During the Great Depression!!

From the period of 1972 to 1982, the above, simple, diversified portfolio (indices only) would have achieve an AVERAGE ANNUAL return of… 14.82%!!  One dollar invested as described above in December of 1972 would have grown to about $3.49 by December of 1982.  During the Carter Years and the Misery Index!!

Were there periods of volatility, market corrections, and even stagnation in the investor’s portfolio?  Absolutely – in particular, a sharp market correction in 1936 would have scared out many undisciplined investors, and a particularly unpleasant 18 month bear market from 1973-1974 would have tested investor mettle.  But the facts remain – a fully diversified, properly balanced investor would have been able to achieve significant returns during those times.  In fact – there are a number of economic theories that suggest that investors who have the GUTS to invest (and remain invested) during these uncertain times are the ones who enjoy the GREATEST rewards.  These are the riskiest, most emotionally draining times to invest – as a result, the Capital Markets reward those investors more readily and more predictibly than the comparatively “timid” investors who only remain invested during the “good” times.

Today, the Fed and the International Monetary Fund (IMF) are projecting the US economy’s GDP growth to be about 2.7% for the next two years.  The media harps daily on the miserable shape of our economy, and politicians are using the economy as opportunities to further their agendas.  These are things that we must endure as a people, or change with our votes.

However – it is critical to SEPARATE our concerns about the economy – from our own INVESTMENT POLICY.  The two are NOT necessarily correlated.  A miserable economy – historically – does NOT mean miserable returns for an investor who is disciplined, creates a sound, diversified, low-cost investment STRATEGY with strict risk controls, and then implements it with courage and discipline.  In fact – it is EXACTLY these types of investors who have historically been the winners over the long term.


This blog article does not constitute legal, tax, or personal financial advice.  Please consult your own financial professional for personal, specific information.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.

How to own a property or business in an IRA?

8 02 2011

Occasionally we get this question – how can I use my IRA assets to buy a rental property or a business of some sort?  Many people over the years have accumulated assets in their company 401(k) and rolled them to an IRA,  or saved money in their IRA throughout their working years, but may have not accumulated any assets in other accounts – accounts not directly considered retirement accounts, and as such, not subject to all the special rules that govern retirement accounts.  As a result, they find it difficult to to invest in rental property or to finance a business startup because of a lack of readily accessible funds. 

So, the question is – how can I use the money in my IRA to buy these types of assets?  Can I?  The answer is – sort of.

The laws governing an IRA are designed to limit IRA’s to saving for retirement – but in exchange for following these sometimes burdensome rules, IRA’s allow for investors to accrue funds while enjoying some significant tax advantages.  Since retirement is the primary purpose of IRA accounts, IRA rules intentionally make it difficult to use IRA funds for any other purpose without suffering a 10% early withdrawal penalty (for withdrawals prior to age 59 and 1/2) and income taxation on funds withdrawn from the IRA.

There are specific exemptions from the 10% early withdrawal penalty, such as the exemption that allows an investor to use up to $10,000 for a first-time home purchase or for education purposes.  However, these exemptions typically do not really allow an IRA owner to finance a business or to buy a real estate as an investment tool.

Fortunately – for savvy investors – there ARE ways to get the job done.  As long as the IRA does not engage in “prohibited transactions,” or own “disallowed” investments – then an invesor can use IRA funds to start a business or to buy investment real estate – if he or she does it correctly.

First – the following transactions are considered prohibited within an IRA:

  • Borrowing money from your IRA
  • Selling your own property to your IRA
  • Using your IRA as security for a loan
  • Buying property within the IRA for personal use

Any of these transactions could result in your IRA being disqualified by the IRS – resulting in a forced distribution of the IRA with all taxes and early withdrawal penalties becoming immediately payable! So, first and foremost, an investor needs to carefully play by the rules governing IRA’s to avoid running afoul of the IRS.

Secondly – certain types of investments cannot be held within an IRA:

  • Collectibles (such as art, antiques, most coins, stamps, etc)
  • Life insurance contracts
  • Derivatives (other than covered calls on stock owned within the IRA)
  • Real Estate from which YOU directly benefit (ie – receive rents directly)

So – back to the original question – How can I use my IRA assets to buy rental property or finance a business startup?  The key to success is to remember that anything purchased by the IRA – and any benefits (such as rental income or appreciation) derived by investments within the IRA –  must be owned by the IRA and remain inside the IRA, lest it be considered a distribution from the IRA.  

So – in order to buy rental property or a business with your IRA – here is what you must do:

  1. You must find a custodian that allows these types of transactions, and has expertise in getting these transactions done effectively and legally.  Most custodians (ie – brokerage firms) do NOT handle or allow these transactions.  You must choose a custodian that specializes in these types of transactions to hold your IRA.  Additionally, you should expect to pay top dollar for their services; you will not get a “free” IRA at one of these firms.  Expect each transaction to have a significant fee, and expect an annual fee on the account.
  2. Once you choose your investment, the custodian of your IRA will then direct your IRA to purchase the investment property or the business within the IRA.  Therefore, the investment property or the business effectively becomes an investment within the IRA itself, and is considered a part of the IRA portfolio.  As long as it is not a prohibited investment – then it is allowable.  Remember – as far as real estate being a prohibited investment – the prohibition is against YOU getting a direct benefit from the property (such as having rental checks made out to you directly).   The prohibition is NOT against your IRA owning a rental or investment property as an investment in an arms-length transaction.
  3. Any mortgages on the property, repair costs, or financing for your business, must be conducted within the IRA itself.  Therefore, the mortgagee on the property bought within the IRA is NOT you – but your IRA.  Any business loan to the business is made to your IRA – not to you.  Generally custodians that specialize in these type of IRA transactions can assist investors in finding lenders who have experience loaning funds to IRA-owned businesses, or for the purposes of repairs or rehab operations on properties owned by IRA’s.  Do not expect these loans to be particularly competitive. 
  4. Essentially – the IRA – under the supervision of a custodian who specializes in these types of transactions – becomes a legal entity conducting business for itself.  Your IRA can even loan money for investment purposes (ie – make “hard-money loans” to other real estate investors), finance the rehab of homes for later resale, and own the business within which you work. 

Many people ask about using their IRA for purposes such as these – but few people ever actually do so because of the complexity of the planning required.  From a financial planning standpoint – conducting these types of investments within an IRA can be profitable – but are also considered to be quite risky, as they introduce additional types of risk (such as liquidity risk, default risk, and business risk) that most investors do not wish to see within their IRA’s.  Additionally, owning a business within your IRA can subject your IRA to what is called “UBTI,” – Unrelated Business Taxable Income.   It is for these reasons that you should always consult with tax and financial planning professionals who are completely familiar with your particular situation, risk tolerance, investment experience, tax situation, and financial goals before actually trying this. 

Many custodians who specialize in these types of transactions advertise how “easy” it can be, and how profitable it can be – but in my experience, few investors whom I have seen actually try these types of strategies have been overly pleased with their results.  Most of them have not significantly improved their financial situation above and beyond what their situation would have been had they merely practiced good financial planning behaviors and invested their IRA funds in a fully diversified, properly constructed portfolio that was appropriate for their risk tolerance.

Information in this article does not constitute a recommendation or solicitation for any product mentioned.  Mutual funds may only be sold by prospectus.  Past performance is no guarantee of future performance.  All investing – including the investing discussed within this article – involves risks of loss.  Consult your financial advisor for specific recommendations.