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Fun with IRAs

IRAs are one of the most popular retirement savings vehicles in the United States. Used correctly, to save for future retirement expenses, IRAs are fairly boring instruments. But they don’t have to be. In fact, IRAs can be fun.

Don’t believe me? Read on.

But first, a disclaimer: Please know that what’s discussed below is extremely ill-advised. It may be legal, but so is hugging a hungry bear. Just because you can doesn’t mean you should.

Okay, with that warning, who’s ready for some fun with IRAs?

This is a true story. None of the details have been fabricated. It seems far-fetched, but it unfolded just over a year ago in the State of Illinois. How do we know it’s real? Because the facts were laid out for all to read in a court order, filed in April of this year. As far as court orders go, this one is a gem – equal parts legal mumbo-jumbo and soap opera.

It goes a little like this…

Richard Jones was down on his luck. He had overextended himself with debts that he could not repay. On the brink of bankruptcy, his mind raced trying to conjure up a way out of his predicament. His bank account was empty, but he owned an IRA stuffed with investments intended for his retirement.

Richard knew the investments couldn’t help him. His debts exceeded the total value of his IRA. But he had a plan. It was risky, but he thought it might work.

He would sell some of the investments in the IRA and distribute the cash to himself. With cash in hand, he would use the proceeds to buy something that held out the prospect for extremely large and essentially immediate returns. If it worked, he would not only dig his way out of debt, he would be rich.

Richard thought through his options. In the end, he could only identify one “investment” that met his needs: lottery tickets.

His plan was even more complex, though. He knew that if he distributed any portion of his IRA, he would have to pay income tax on the proceeds. Not only that, he would also face a 10% penalty.

Richard, however, was aware of a quirk in the IRA rules, and he planned to exploit it. The rule allows an IRA owner to avoid taxes and penalties on an IRA distribution as long as the proceeds are placed back into the IRA within 60 days of the initial distribution.

Richard saw it as a 60-day, interest-free loan. And it was just what he needed.

Amazingly, nothing in his plan was illegal. It’s true. An IRA owner can distribute any amount from an IRA, use the proceeds for any purpose, and avoid any taxes or penalties – at any age – as long as the proceeds are returned to the IRA within 60 days. No questions asked.

With his plan in place, Richard set out to execute it. He withdrew $50,000 from his IRA. He deposited the funds into his personal checking account, and over the next few weeks he bought lottery tickets. A lot of lottery tickets.

As old tickets expired worthless, he bought more lottery tickets. Ticket after ticket, Richard failed to win. The plan began to unravel. He finally threw in the towel after losing a grand total of $30,000. Defeated and down on his luck, he returned the remaining $20,000 back into his IRA.

For his efforts, the IRS and the Illinois Department of Revenue hit Richard with tax liabilities exceeding $9,000 on the $30,000 that he did not return to his IRA. Ultimately, Richard filed for bankruptcy.

The fact that everything in Richard’s plan was above-board is amazing. To be honest, Richard probably should have chosen a similarly bone-headed but at least higher probability plan. He should have gone to Las Vegas.

Think about it. Assuming Richard played the Illinois lottery, his odds of winning would have been around one in 20 million. The payoff would have been in the millions. Instead, he could have distributed the money from his IRA, bought a two-way plane ticket to Vegas, plopped down at a roulette table, and bet $30,000 on black. His odds of winning would have been one in 38. The payoff would have been more than $1 million.

In a statement that would surely please Yogi Berra: If you are going to do something dumb, at least be smart about it.

Lottery tickets? A Vegas gambling trip? See, IRAs can be fun. As long as it’s not your IRA.

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