Should You Borrow for Your IRA?

RAY and DANA BRANDON

Ray’s Take: When that first W-2 arrives you know it is tax season, which for some people will last longer than the 2011 baseball season.

For tax professionals and financial planners it’s a busy time, and it’s open season on tax questions.

For example, a young woman who had no 401(k) through work asked me if she should borrow money to put into her IRA. She had $5,000 in stocks, but she didn’t want to sell them and pay taxes on the gains.

I asked how she was going to borrow it, and she said through her home equity line of credit (HELOC) at 3 percent. I asked her what her tax bracket was, and she replied 30 percent.

It was pretty straightforward. If she borrowed $5,000 from her HELOC and paid it into an IRA, she would gain $1,500 in her refund. If she put that toward her HELOC balance and paid $300 a month for 12 months, it would all be paid off. Her interest paid would be a little more than $100 (tax deductible) and she would have a $5,000 retirement asset.

Now, I’m not a big fan of debt. But, in this case, it made financial sense. There’s one critical factor to consider, the human factor.

Was she disciplined enough to pay the $1,500 of her refund to her HELOC and make the 12 monthly payments of $300?

What if she didn’t pay it off and $5,000 continued to ride month after month on her HELOC. And, what if the rate on the credit line rose as the economy improved. In 12 months she could be paying a higher rate and in 24 months an even higher one.

It’s easy to theorize about borrowing money with the intention of saving in the long run. What’s hard is seeing the plan through, especially if it requires sacrificing things you enjoy.

Dana’s Take: The woman Ray described was fortunate to have a low-interest credit line tied to her home’s equity.

Lately, I’ve had friends burned by low-interest credit card offers. One saw an offer for 3.5 percent APR until 2013. She enrolled, was approved and hastily transferred all her credit card balances to that card.

In her first statement she was shocked to see a one-time 3 percent transfer fee had been applied to the entire amount. So really she was paying 6.5 percent.

She later discovered that the new card and the high balance lowered her credit score.

Thanks to new credit card regulations, the fine print on credit cards isn’t as hard to read as it used to be. But, you do have to read it.

Don’t assume new regulations have eliminated credit card pitfalls. When government regulation closes a door, banks open a window.

Ray Brandon is CEO of Brandon Financial Planning (www.brandonplanning.com). His wife, Dana, has a bachelor’s degree in finance and is a Licensed Clinical Social Worker (LCSW).
Contact Ray Brandon at raybrandon@brandonplanning.com.