Wendy Wise Elects to Take a $50,000 Perk She Forgot She Had To Fund A New Investment

In the prior issue, Wendy decided to place a little less than 10% of her retirement savings, 50K, in a private placement as an independent drilling contract, IDC, in oil and gas development as a general partner. Although this investment would provide both income and potential principle as a new cash source for pre and post retirement years, this investment is outside of all her tax qualified retirement plans.  Since the latter is where Wendy had all her money, she asked if she could take money from her IRAs to fund the IDC. “Absolutely not” I answered. Doing so would trigger a 10% pre-mature distribution penalty and more income taxes. “Well, where am I going to get the $50,000 to get in on this IDC?” she asked curiously.

We reviewed her 401k plan and concluded that she could borrow up to $50,000 from it. I explained the advantages. The benefits to her are as follows:

• No current taxation for the distribution

• Competitive interest rates with no credit check.

• A generous five year repayment period

• Interest she pays is credited back to her in her own account, not some bank.

• Her total investment portfolio value would not change. She is taking dollars from one investment and adding to another.

This IDC investment would cut her federal income taxable income by $10,000 per year for five years (see previous article). Contrasted against her 2010 tax filing, these savings equal about 1/4th the amount she’s considering borrowing from her 401k plan – or about $12,500 in new-found cash flows.

A review of her current financial planning shows that she now has three new sources of significant cash flows:

1. State and federal income tax reductions;

2. Over $7,700 annual savings from refinancing her mortgage;

3.  Long-term IDC income beginning small within the first year of investing and leveling or growing more slowly sometime after her third year when all her wells are producing.

In sum, her after tax cash flows gained from financial planning, would exceed her repayment amounts to her 401k plan by several thousand dollars once tax savings is added to her projected 2012-2017 IDC income.  Since Wendy understood that she would net thousands more in cash annually after paying $10,000 a year to her 401k, she thought the 401k loan for the IDC investment was clever.

Wendy filled in the loan application and gave it to her employer. Within days it was approved and Wendy Wise became an energy entrepreneur without a single ounce of sweat and lots of new capital to boot! Her financial star continues to rise.  She now has a diversified investment portfolio inside and outside her retirement plans, a private placement with an IDC, low mortgage payments and low interest payments on her mortgage, low taxes, and steady cash flows – all created with new-found cash sources.

Wendy asked when we could meet again. Next week we’ll review her biggest risk – outliving her money – and see what she can do about it.  Until then, she’ll sit down with her employer and and implement her tax savings by cutting her income tax withholdings by 75%. This will provide immediate cash  to help cover her 401k loan repayments.