Why we Liquidated our Traditional IRAs in our 30s and How we Mitigated the Taxes

Retirement accounts like Traditional IRAs are often touted as the cornerstone of long-term financial planning, but for us, they became a constraint rather than a benefit. After careful consideration, we decided to liquidate our Traditional IRAs, driven by five key reasons. Below, I outline why we made this choice and the strategies we used to mitigate the tax consequences of liquidation.

Reasons for Liquidating Our Traditional IRAs

1. Limited Investment Options in Traditional IRAs

Traditional IRAs, especially those tied to employer-sponsored plans, often come with restricted investment options. These plans typically steer you toward mutual funds, which may have high fees and limited growth potential. When managed independently, platforms like M1 Finance offer significantly higher growth potential through diversified, high-return portfolios. For example, our M1 account has achieved a time-weighted return over the last year of between 30-70%, far outpacing the returns of typical IRA mutual funds. Liquidating allowed us to redirect funds into these higher-growth opportunities.

2. Lack of Marginability

Retirement accounts, including both Traditional and Roth IRAs, are not marginable, meaning you cannot borrow secured by them to amplify your investments. By liquidating, we unlocked the ability to use margin—increasing our investment capital by 40% or more.

3. Access Restrictions

IRAs impose age-based restrictions, requiring you to wait until 59½ to access funds without penalties. We didn’t want our financial freedom dictated by arbitrary age limits set by financial industry regulations. Liquidating gave us immediate control over our money, allowing us to invest and grow wealth on our terms without waiting decades.

4. Step-Up in Basis for Heirs

Traditional IRAs create tax burdens for heirs. Upon the account holder’s passing, beneficiaries must withdraw the funds within 10 years under IRS rules, treating distributions as ordinary income and incurring (possibly significant) taxes. By liquidating now, we shifted our investments into assets that qualify for a step-up in basis upon death. This means our children inherit the assets at their current market value, free from ordinary taxes, providing them with a tax-efficient inheritance instead of a tax burden.

5. Forced Taxable Distributions

Traditional IRAs force taxable distributions starting at age 73 through Required Minimum Distributions (RMDs). These withdrawals are taxed as ordinary income, potentially at high rates, even if you don't need the money. By liquidating our accounts now and investing in tax-friendly assets, we avoid these forced distributions and the associated ordinary income taxes entirely.

To illustrate, consider our $200,000 Traditional IRA growing at a generous 8% annually. I'm currently 38, so in 35 years at age 73, the account would be worth approximately $2.96M. The first RMD, based on the IRS Uniform Lifetime Table divisor of 26.5 for age 73, would be about $112k. At our effective tax rate of 33% (I assume this will be the same, if not more by the time I’m 73), this would result in roughly $37k in taxes for that year alone—and RMDs continue annually, increasing as the account grows or divisors decrease.

At age 59.5 (in about 21.5 years), when penalty-free withdrawals begin, the account would be worth around $1.03M. If we withdrew the full amount then simply to avoid the 10% penalty now, it would be taxed as ordinary income, leading to a hefty tax bill of approximately $340k at 33%—far more than the $86k tax hit (including penalty) we're taking now by liquidating.

By liquidating today and investing in tax-friendly ETFs and stocks, we pay the $86k upfront (in 15 months actually), but avoid these future income tax burdens.

Our Thoughts on Contributing to Company 401(k)s

Our decision to liquidate Traditional IRAs aligns with our broader skepticism about company 401(k) plans as I detail in my blog on “Why you May want to Rethink your 401(k) Contributions.” In my opinion, while employer matches are appealing, they often don’t outweigh the downsides of being locked into suboptimal investments and facing forced distributions later. We prefer redirecting those funds into flexible, high-growth accounts in M1 Finance, where we can leverage margin, diversify into tax-efficient assets, and maintain control without waiting until ‘retirement age.’ Liquidating our IRAs was a step toward this philosophy, prioritizing freedom over traditional retirement vehicles.

Strategies to Mitigate Tax Hits

Liquidating a Traditional IRA triggers taxes and, if under 59½, a 10% penalty. We used a few combined approaches to manage these costs, balancing immediate tax hits with long-term growth.

Strategy 1: Liquidate and Reinvest with Margin

For one $200k Traditional IRA, we chose to simply liquidate and reinvest the funds. Assuming an effective federal tax rate of 33% and a 10% penalty for early withdrawal (as we’re under 59½), the tax breakdown is as follows:

• Penalty: $20k (10% of $200k)

• Taxes: $66k (33% of $200k)

• Total Tax Liability: $86k

Since liquidation occurred in January 2025, taxes aren’t due until April 2026, giving us 15 months to invest $200k before settling the tax bill. Some places will default to a 10% pre-payment withholding when you liquidate, but this is not required per the IRS in my research (be sure to check with your institution). We invested the $200k in our M1 Finance account, which we conservatively estimate earns 20% (though our best portfolios over the last year have been 30-70% time-weighted returns). Additionally, we used 30% margin to increase our investment to $260k ($200k + $60k margin).

Breakeven Calculation

• Investment Growth: $260k at 20% compounded return, yields a portfolio value of approximately $334k after 15 months (when taxes are due).

• Paying Taxes via Margin: Because we can build our M1 Finance pie to ensure 40% (or more) margin available on the account, we could borrow up to $134k against the $334k portfolio by April 2026. Considering the $60k already margined on the account, this leaves $74k in margin to pay the taxes. While this doesn’t full cover the $86k tax liability, we are ok with liquidating some of the already margined amount in the account or margining another account to cover the remainder of the taxes if our other strategies don’t reduce this liability. This leaves the full initial amount of $200k invested and continuing to grow even after paying taxes.

• Breakeven Point: In 19 months from January 2025 (when the account was liquidated), the portfolio’s cumulative growth reaches $86k and fully offsets the tax liability. The portfolio continues to grow exponentially thereafter.

Using margin to pay the taxes ensures the entire initial $200k stays invested. The short 19 month breakeven period (in our opinion), combined with the ongoing flexibility of margin, no age restrictions, and a step-up in basis for our heirs made this approach highly advantageous to us. And bonus, we don’t have to worry about our future unknown tax bills!

Strategy 2: Traditional IRA to Roth IRA Conversion with Strategic Investments

For another $260k Traditional IRA, we opted for a Roth IRA conversion to avoid the 10% penalty while strategically managing taxes. We invested the funds into US Energy LLC units, which offer unique tax advantages and income potential through energy projects. Investing in oil and gas also diversified our broader asset portfolio. Please note, this type of investment is for accredited investors only (annual income exceeding $200k individually or $300k combined OR a net worth exceeding $1M either individually or combined). Here is how it works:

1. Invest in an LLC: We invested our $260k traditional IRA to buy 2.6 units in an oil and gas LLC through Centurion Strategic Advisors, Inc.

2. Revalue the Assets: After just under a year, the LLC’s assets (wells, equipment) were revalued, factoring in depreciation and depletion. The $260k investment dropped to $75k on paper due to tax-advantaged accounting.

3. Convert to Roth: At this point, the investment is converted to a Roth, paying taxes only on the revalued amount of $75k. Assuming our 33% effective tax bracket, that’s $25k due in taxes - saving us $61k in taxes compared to taxing the full $260k.

4. Earn Tax-Free Income: The investment pays ~14% annual distributions, paid quarterly ($36k/year) into my Roth, growing tax free. I can transfer that money to my M1 Finance Roth for even larger ongoing growth.

5. Offset Remaining Taxes: The last step to make this completely tax free was to invest $82k in another oil and gas LLC (outside of the IRA). After intangible drilling cost ‘losses’ (typically 70-100% of the investment), this $82k becomes a loss of approximately $75k, thus reducing our taxable income and wiping out the remainder of the conversion tax bill.

While the oil and gas Roth conversion strategy avoided the 10% early withdrawal penalty, it lacked the immediate and long-term marginability of fully liquidating our traditional IRAs. The Roth’s tax-free growth comes with a restrictive structure that limits access to our capital, which conflicts with our preference for greater financial agility. In retrospect, liquidating both IRAs might have maximized our investment flexibility and opportunities, however we’re grateful for the diversification this approach added to our overall asset portfolio.

Other Potential Tax Savings Strategies

In addition to the strategies above, we explored further ways to offset the tax liability from liquidation.

For instance, a cost segregation study on our real estate holding could accelerate depreciation deductions. By reclassifying certain property components to shorter depreciation lives, we can claim larger upfront deductions, potentially reducing taxable income in the year of IRA liquidation (assuming one of us can qualify as a Real Estate Professional (REP)). However, we opted against this, as we’re considering selling the property, and our CPA advised caution due to potential recapture complications. For those committed to holding property long-term or with multi-family units in particular, this is a powerful tax-saving tool.

Similarly, losses from our family business can be deducted against the ordinary income generated by the IRA liquidation. If the business incurs net operating losses, these can offset taxable income, providing another layer of tax relief. Combining these with our primary strategies helps minimize the overall tax impact while keeping our investments growing.

Why It Was Worth It

Liquidating our Traditional IRAs gave us control, flexibility, and the ability to pursue higher returns through platforms like M1 Finance and strategic diversified investments like oil and gas LLCs. The tax hits, while significant, were mitigated by leveraging the delay in tax payments, using margin to both amplify investments and cover tax liabilities, and employing tax-advantaged investments to offset taxes. The breakeven period for liquidation was short enough to justify the move, and the step-up in basis ensures our children inherit wealth without a tax burden. For us, breaking free from the constraints of Traditional IRAs was a calculated step toward financial freedom on our own terms.

Would you do it?! Drop us your thoughts in the comments!

FINANCIAL DISCLAIMER

Do your own research! We are not providing nor are we intending to provide any sort of financial, tax or legal advice. This article simply includes details of our decision making process on the topic. Everything is of course, subject to market fluctuation. Please always be informed and consult your professionals prior to making changes.

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