Quote:
Originally Posted by CoachKandSportsguy
The scenario:
They needed a small amount of money to improve the second home.
Small meaning $0-50K, exact amount uncertain. Lets use $50K for simple back of the envelope calculations
They have a substantial IRA, and live well on pensions and IRA withdrawals.
I recommended taking the amount out of the IRA.
They consulted their financial advisor, his advice was to take out a home equity line of credit. So they proceeded down that road. Cost of interest is 7%
I asked how the financial advisor was compensated. The reply was "he gets a percentage of assets under management" The advisor told them that taking money out of the IRA would require taking out the amount plus a *huge* amount for taxes."
So here is the financial trade off with simple math:
Take out $50K from IRA, plus 22% for taxes = about $61K, est $11K for taxes
vs
Take out $50K, pay about $3,500 per year in interest. After 3 years, the interest payments are approximately $10,500. The interest qualifies for tax deductibility due to loan against the property for upgrades. The interest can only be deducted if the filer itemizes, which the couple does not. Therefore the interest is not tax deductible.
Conclusion:
Keeping the home equity loan costs more in interest if the loan is held for more than three years versus the one time tax payment. The relatives did not figure that part of the equation because they trusted their financial advisor to give them unbiased, fiduciary advice.
The money manager convinced the couple to avoid removing money from his paycheck using the fear of huge taxes. . without being specific about the trade off.
Remember Charlie Munger's quip:
"Show me the incentive plan and I will show you the resulting behavior"
Never fear taxes, just remember to understand and remember to use taxes in your financial decision.
good luck out there, its a financial jungle where everyone is looking at you for a meal
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You are right. You might also ask if your relatives are also taking money out of their IRA. If they are still working, I’d say don’t touch the IRA. However, I live on Social Security and my mutual funds. I receive money every month from my mutual funds. The company takes 20% of that and sends it to the IRS. Some of it I may get back. If I’ve already paid 20% tax on what came from my ITA, and then I use part of that every month to pay off a home equity loan at 7%, that changes the equation.