Some individuals may be reluctant to invest their retirement savings in common stocks or mutual funds due to fluctuations in the markets over time, which may lead to the loss of some of their retirement savings. To address this fear, certain “entrepreneurial” fiduciaries have introduced what are known as “Self-Directed Retirement Accounts” that offer the individual the option to invest their retirement savings in other avenues, such as rental real estate or in starting their own small business.
Such fiduciaries charge high fees to file the necessary paperwork with the IRS to establish such Self-Directed Retirement Accounts and file the required annual reports with the IRS. Generally, they do not offer advise with respect to the selection and management of alternative retirement savings investments.
I am not a fan of Self-Directed Retirement Accounts and would never recommend this strategy to my clients. Since 2010, I have had exactly one (1) client who achieved financial success in pursuing their “Self-Directed Retirement Account” investment strategy. All the others lost money. Some, especially those who used their retirement funds to start their own small business, lost everything.
My advice: leave the investing of your retirement savings to the professionals.
In general, it is never a good idea to borrow funds from your retirement accounts, regardless of the purpose or your intent. Consider this option only as a last resort, after you have exhausted all other possible financing alternatives first. Here’s why:
- Whatever amounts you borrow are no longer available in your account, compounding and earning more money for you. The power of compounding is the fundamental, underlying principal behind saving money in retirement accounts in the first place, as discussed above.
- If you are terminated from your job or decide to quit, the entire outstanding loan balance will become due and payable in full within 60 days of your termination. If you are unable to repay the entire balance within the 60-day repayment period, the entire outstanding loan balance will be reclassified as an early withdrawal and reported on Form 1099-R, which is taxable as ordinary income. Furthermore, if you are younger than age 59 ½, the entire amount will be subject to the IRS early withdrawal penalty of 10% of the outstanding loan balance.
The only time to consider borrowing from your retirement accounts is when you are faced with an emergency, and there is no other financing alternative available. Before resorting to withdrawing retirement funds, look into home equity lines of credit (HELOCs) or refinancing your mortgage or other debt.