$3.8M Net Worth, $0 Cash: What Should They Do?

The Couple's Financial Snapshot [0:39]

• Assets total $4.7 million, including a $2.3 million liquid financial portfolio and $1.5 million in real estate with $840,000 equity.
• Their net worth is $3.7 million.

• "We have a net worth of $3.7 million, a financial portfolio alone of $3.25 million."

Income vs. Expenses [1:28]

• Annual take-home income is $151,000.
• Spending is $166,000, resulting in a $15,000 deficit.
• This deficit doesn't include $120,000 in unexpected medical expenses, bringing the total annual shortfall closer to $135,000.

• "And spending is $166,000 against $151,000. So there's a negative of about $15,000 for this year."

The Liquidity Dilemma [2:08]

• The couple has only $6,300 in cash.
• Their liquid portfolio is primarily in 401(k)s ($2.3M), with smaller amounts in Roth ($227K) and HSA ($51K).
• Accessing 401(k) funds before retirement age typically incurs penalties or requires specific withdrawal strategies like 72T.

• "I mean, I think we're an example of, I know you don't like the term anymore, but that middle-class trap, because we've spent so much of our time in corporate life putting into our 401ks and looked up and went, we can't get to this money."

Real Estate and Home Equity [3:19]

• Their real estate portfolio has $840,000 in equity.
• They have a $273,000 HELOC on a $600,000 property.
• The HELOC has been used to cover expenses, contributing to their current financial strain.

• "So that leaves your home equity and you've already used that as a source of liquidity to this point with $273,000 HELOC that we see in the position, right?"

The Medical Expense Deduction [5:02]

• A potential tax break involves deducting unreimbursed medical expenses exceeding 7.5% of Adjusted Gross Income (AGI).
• With $100,000 income and $120,000 in medical bills, they could potentially deduct $112,000, significantly reducing their taxable income.
• This could allow for Roth conversions up to their deficit amount ($11,600) tax-free.

• "The IRS allows you to deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income."

72T and Roth Conversions [6:45]

• A 72T (Substantially Equal Periodic Payments) allows penalty-free access to retirement funds before 59.5, though income tax is still paid.
• The medical expense deduction could create room to Roth convert funds tax-free or at a low tax rate.
• However, Roth conversions are for long-term savings and not immediately accessible cash.

• "You could also start a 72T and that will give you cash flow now."

Real Estate Sale and ACA Cliff [8:17]

• They are under contract to sell a property for approximately $210,000.
• Proceeds from the sale could push their income over the ACA subsidy cliff, significantly increasing health insurance premiums.
• The ACA premiums are projected to rise by 17% next year.

• "And our concern with that is we're on the ACA right now. So if our income goes over a certain amount and those proceeds would, we would hit the cliff."

HSA and Roth Basis [10:00]

• They have $50,000 in an HSA that could be used to offset expenses.
• A portion of their Roth IRA balance ($80,000+) is basis, which can be withdrawn tax- and penalty-free.
• Using Roth basis could provide some liquidity.

• "Yes, we definitely have access to the HSA. We have about $50,000 in that that we could use this year or next to offset some of the expenses."

1031 Exchange Considerations [13:00]

• A 1031 exchange is being considered for the property sale proceeds to defer capital gains taxes.
• The plan involves reinvesting the proceeds into another two-unit property.
• The debt levels would remain similar, offering no immediate cash flow benefit but avoiding taxes.

• "What we envision is we'll have about a little bit over 200,000 in proceeds going into 1031."

72T for Liquidity [15:40]

• A 72T can provide immediate cash flow, though it's taxed.
• The medical expense deduction could offset the tax liability on 72T withdrawals.
• The 72T payments must continue for five years or until age 59.5, whichever is longer.

• "Now they just have to set up a 72T to do this. And you have to take the 72T money for five years or until you hit age 59 and a half, whichever's longer."

Spending Analysis [19:40]

• Their current annual expenses are around $166,000, averaging $12,000-$13,000 per month.
• Housing costs are $2,400/month (taxes, insurance, household expenses), with no mortgage.
• Food and dining is $2,000/month, noted as a potential area for tightening.

• "Housing expense of $2,400. That's not ridiculous."

HELOC Debt Concerns [25:50]

• The HELOC balance is $273,000, with a $1,250 monthly interest-only payment.
• This debt was intended to be short-term but has ballooned.
• Paying off the HELOC over five years would require $4,550 monthly payments (principal and interest).

• "I don't like that answer. Is that your interest only on the HELOC? Yes. And then what about the housing expense of $2,400?"

Tax Projection and ACA Cliff [30:00]

• A tax projection tool estimates their MAGI is very close to the ACA cliff ($128,600).
• Going over the cliff could eliminate a $14,000 annual ACA subsidy.
• The exact income projection is critical for decision-making.

• "I got you over the cliff. Oh no, I got you just under the cliff. Man, this is too close for my tools."

Real Estate Commission Strategy [34:00]

• Selling the rental property this year could provide $200,000+ in liquidity.
• If they go over the ACA cliff, selling the property and paying taxes might be preferable to deferring it.
• The timing of commissions is crucial due to the ACA cliff.

• "It's kind of a weird and perverse incentive to not sell that one extra property between now and the end of the year and get that commission into next year. If you can."

Unreimbursed Medical Expense Deduction [37:45]

• This deduction is highlighted as a potential "gift from the IRS."
• It can significantly reduce taxable income and potentially allow for tax-free Roth conversions or low-tax 72T withdrawals.
• Experts emphasize consulting a tax professional to maximize this benefit.

• "Yes, definitely go look into that. I agree with Scott. You should connect with a financial planner as well as a CPA or a tax professional."

RMD Tax Bomb Potential [40:00]

• With a $2 million 401(k) balance in their early fifties, they face a potential "RMD tax bomb" in retirement.
• Strategically accessing funds now via 72T or Roth conversions can mitigate future RMDs.

• "The $2 million in the 401k is both a huge opportunity and a potential tax bomb for you specifically."

Bridging the Gap [43:00]

• The primary issue is liquidity, not a lack of net worth.
• Key levers include expense reduction, Roth conversions, HSA utilization, and potentially accessing Roth basis.
• Consulting an hourly financial planner is strongly recommended due to the complexity and interconnectedness of their financial situation.

• "The point here is about this like middle class trap or liquidity challenge. And it does not really apply to the people who are not multi, multimillionaires already on the journey there."