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Illiquid stocks, credit card debt, founder's low salary, and a couple of IRAs?

I'm the founder of a company that recently took a small investment so that I could pay myself $48k per annum. I won't have visibility into the success of the company for at least 9 months and I'm in the situation now where I'm trying to deal with credit card debt.

Assets: $7k Traditional IRA $80k Rollover IRA $100k-$250k Illiquid Stock from a previous company that won't be available for 1-3 years (if ever)

Debt: $20k Credit Card debt at 10% interest

The $48k salary is enough to pay basic expenses but no more - I may have to incur more debt in the next 9 months and want to get feedback on liquidating part of the IRA and if so which one first. I understand that there will be a 10% penalty and that it will be hard to get that sum back into the IRA in the future because of annual contribution limits but I really hate debt.

I'm 37 years old, married, and live in Kenya - but am a US citizen.

Nov 14, 2013 by adam from New York, NY in  |  Flag
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7 votes
Carlos P. Sava Level 13

Adam - Thanks for sharing the details of your situation. I nearly always think that liquidating or pulling an IRA early should be the option of last resort, along with selling your home. From a personal finance standpoint, you also want to keep your credit score in tact to preserve options later. Allow me to suggest a few other alternatives before quantifying the IRA distribution. First, could you apply for a new credit card(s) that have 0% interest rates for balance transfers? There can be a fee, say 3%, but it would give you breathing room for a year until your visibility in the business improves, your illiquid stock can be cashed out, or some other windfall. Second, is any portion of the credit card debt related to your business? Getting it onto the Company's balance sheet rather than your personal balance sheet could be helpful. (Consult a tax expert, particularly if International and foreign based entities are involved)? Third, carefully approach your investors and explain your concern and worry over having credit card debt. They may be willing to offer a lower priced loan (5%) to you, or up their investment in your Company. Your investors believe in you and don't want you to be worried about personal debts. Fourth, take a hard hard look at your budget and trim away "luxuries" like cable TV, no fancy coffees, bring lunch from home, etc. Are there side projects you or your wife could do for extra income?

If all of those alternatives are exhausted, it's time to look at the IRAs for proceeds to pay the credit card debt. IRA money is an expensive source of personal capital, because not only does it have the 10% penalty off the top, but that money then has an opportunity cost of the income / appreciation it would earn in the first year, but then the compounding affect of that money over the next 30 years until your retirement. Since both accounts sound like Traditional IRAs now, there shouldn't be a difference. I would combine the two accounts, or if you prefer the firm with the larger balance, close the smaller account, though there is an administrative trade-off of having two early withdrawals. If the rollover was a Roth 401k (less common), that would change things, as would if it was "inherited" rather than rolled over from a previous employer 401k account in your name.
Good luck with the new business and this difficult decision.

1 Comment   |  Flag   |  Nov 14, 2013 from Arlington, VA

Carlos, thanks for the measured response. A few things that I kind of forgot about in the original question.

There is also $30k in IRS payments owed because the value of the illiquid stock apparently counts as a capital gain. This seems crazy to me but the company in whose equity I own a portion, has offered to buy it at a lowball rate. My accountant thinks this is sufficient to trigger a tax burden even though the offer would be untenable to accept.

The credit card debt does not include company debt on my personal cards. I've already taken that off.

The Rollover is from a standard 401k.

My income tax rate will be lower now than probably any year for a long time - I presume that not being resident in the US this year and having such a low salary - there won't be a better year to do this before I retire.

Flag |  Nov 17, 2013 near New York, NY

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Adam one correction with taking a loan out from a 401k plan, is that you are paying it back to your self, true but you are paying it back with after tax moneys, once the money are back in to your account they become taxable when you take them out later in life, hence double taxation

Comment   |  Flag   |  Nov 14, 2013 from Farmington, CT

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You’ve received a lot of very the good advice from Carlos. Here is one more idea although I know it is a long shot. If your employer/company has a 401(k) plan and (a) allows rollovers into the plan and (b) allows loans, you could consider rolling your IRAs into the 401(k). You would be able to borrow $50k with a 5 year amortization schedule. The interest rate will be irrelevant because the loan interest will actually go back into your 401(k) account. The cost of the loan is the lost upside, if any, while the money is out of the market.

Even if you can do this I would still consider the options Carlos provided first. I’m not a big believer in 401(k) loans but at least you can get the money back into the tax deferred account and there are no income tax or penalty consequences as long as you repay the loan on schedule.

Comment   |  Flag   |  Nov 14, 2013 from Woodbridge, VA

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Adam, it sounds like you are involved in this business venture, and you are ambitiously looking for it to move forward. You have basically $87,000 in IRA’s. If you withdraw money to pay a credit card, you have to pay income tax plus 10% penalty, and you are only paying 10% on the credit card. It would not make sense to me.

I think you are going to do what your gut tells you to, but you are talking of incurring more debt when you just do not have the money to do so. Of course, I don’t have all the details, but I am sorry to say that it does not sound financially sound

View all 5 Comments   |  Flag   |  Nov 15, 2013 from Delray Beach, FL

But I'm not sure what your advice is other than simply abandon the business and get a job.

Flag |  Nov 18, 2013 near New York, NY
Michael Steven Greenberg, CFP®

Here is all that I know.. you have equity in a business that is illiquid....The bright side to that is although it is illiquid, they offered you something, so someone thinks there is value. You then went ahead and started another business venture for 48k. I know nothing about either business and very very little about you... I see an entrepeneurial spirit in you that is commendable; hence my comment you will do what your gut tells you. I have seen many people...myself included that have invested in a business that either never got off the ground, or was going in the wrong direction, only to lose everything. I am not saying this will happen to you, just from the limited info I have, my advice would be to not start a venture you were comfortably prepared to finance. and that ship has sailed. So at this point, I don't think I can make a judgement that you should or should not take an early withdrawal from your IRA. I think in the end, if you need it you will probably take it, and I think you might do just fine. Just as a financial advisor with the info I have, I cannot call it sound financial planning

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Flag |  Nov 18, 2013 near Delray Beach, FL

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All good answers... But, remember that is you withdraw money from your IRA accounts, those funds will not only incur a 10% Federal penalty, but will also be taxed as ordinary income as well. So, assuming you might be in a 28% marginal bracket, your penalty and tax would equate to a 38% reduction after tax. I really think the suggestion to meet with a qualified CPA and/or CFP before deciding which way to go. Best Regards, Rod

Comment   |  Flag   |  Nov 14, 2013 from Springfield, MO

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