I don’t think you have everything sorted out correctly.
There is no 20% tax bracket. The tax bracket you are in is the rate at which the next dollar of your ordinary income is taxed. For the purpose of this discussion, let’s say you are in the 25% tax bracket.
Here are your options as I see them.
Option 1 – Cash out the 401K.
The cash out is taxed as ordinary income. In the 25% tax bracket, your $70K 401K withdrawal will be taxed as ordinary income and the tax hit will be $17500. In addition, you will be subject to a 10% early withdrawal penalty for an additional $7000. After taxes and penalties, you will have $45500 left to invest however you wish.
The income from your investments from this point forward will be taxed at the tax rate that applies to the character of the income. Ordinary income will be taxed at your tax bracket rate. Capital gains will be taxed at the capital gains tax rate that applies to your tax bracket.
Option 2, rollover to a Roth IRA.
A direct rollover is not possible. You can only rollover from a 401K to a Traditional IRA. If you have your plan administrator do the rollover so that you take no money out of the 401K, then the rollover is tax free. Once you have a Traditional IRA, then you can convert to a Roth provided you are under the income cap for the conversion.
This IRA conversion is also done as a rollover, but in this case you are converting pre-tax funds to post-tax funds and will be hit with the tax that you would have paid on the conversion funds if they had been deposited into a Roth IRA from the beginning. Since Roth contributions are made with money you have already paid taxes on, the conversion amount will be taxed at your ordinary income tax bracket rate. Your tax hit on the full $70K will be $17500. Where the money comes from to pay the tax may also subject you to an early withdrawal penalty if the taxes were withheld from the Traditional IRA.
Opton 3 – Rollover to a Traditional IRA.
If your 401K plan administrator does the rollover for you, the full amount of your 401K is rolled over tax free. If you have your traditional IRA established as a self-directed IRA, then your real estate investing can be done inside your IRA without a tax consequence until you make withdrawals from the IRA.
Early withdrawals from your self-directed IRA are also taxed as ordinary income plus a 10% early withdrawal penalty.
Now, with your IRA/LLC strategy, I suppose you are planning to use the IRA funds to loan money to your LLC for whatever investment the LLC will undertake. The profit from the LLC investment will be used to reimburse the IRA and the remainder stays in the LLC. Meanwhile, the LLC pays the IRA interest on the loan until the loan is repaid. In the end, the net income earned by the LLC is taxed at whatever tax rate applies to the character of the income. If the income is long term capital gain, the tax rate is 15% through 2010. If the income is rental income or short term capital gains, then the tax rate is the same as your ordinary income tax bracket rate. If your LLC is engaged in an active income business, then self-employment income taxes may also come into play in addition to ordinary income taxes.
Since the IRA made a loan (you did not make a withdrawal), no early withdrawal penalty applies. Let your IRA custodian guide you so you avoid prohibited transactions and unrelated business income tax issues.
Option 4 – take a loan from your 401K.
If your plan permits a loan, you can borrow from your 401K. You will pay interest on the loan and it must be fully repaid within five years to avoid early withdrawal penalties on any unpaid amount. There is a limit on the amount that can be borrowed. You also risk incurring an early withdrawal penalty if you lose your job and can’t repay the loan.