Talk of The Villages Florida - Rentals, Entertainment & More
Talk of The Villages Florida - Rentals, Entertainment & More
#1
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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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#2
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I agree. I would add that the 7 percent interest is an additional payment that never needs to be paid if you don't borrow money. But, taking an IRA distribution and paying the tax is just paying taxes that you would eventually need to pay at some future time anyway.
Last edited by retiredguy123; 06-28-2025 at 09:37 AM. |
#5
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Also you assume the extra 50K will not put them in the 24 percent tax bracket. Good points as each persons situation is different and the advisor was probably too lazy to do the actual math. I know banks are getting more transparent with their interest tables so it’s right there in front of you.
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I will say the things that others are probably thinking but afraid to say. |
#6
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Another reason to NEVER pay asset under management (AUM) fees to a financial advisor. Exception would be very low fees charged by Vanguard (0.3%) and others if you desire advice. Their advisor needs to look up the definition of “fiduciary “.
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#7
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I'm sure the OP knows but adding also need to take IRMAA and RMD's into consideration. Thanks to inflation, I'm fairly confident we'll end up paying more taxes on our 401K funds than we would have putting that money into a Roth or after tax account. Last edited by Altavia; 06-28-2025 at 03:34 PM. |
#8
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Too, the market is at or very near its high so perhaps a good time to harvest some gains as Buffett has done. Methinks the FA is very fond of his AUM fee and wants to keep it as large as possible.
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"No one is more hated than he who speaks the truth." Plato “To argue with a person who has renounced the use of reason is like administering medicine to the dead.” Thomas Paine |
#9
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Our financial guy suggested we take money from our cash account this year, instead of using any of our zero balance equity accounts on our homes. Maybe a new financial guy is in order
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#10
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The 50K in the IRA would probably appreciate over the coming three years, so that estimated appreciation has to be credited (after accounting for future taxes) against the interest expense on the HELOC.
On the other hand the taxes on the IRA will at some point need to be paid regardless of whether or not they withdraw the money now. That tax expense is postponed, but not avoided, by funding the home improvement with a HELOC. |
#11
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The cost of money from an IRA is one time fixed. The cost of money of a HEloan is for as long as you have a balance, plus there is a cost of application. The incremental tax rate is 22% and there is no IRMMA threat. If the cost of a home equity loan is 7% and the average stock market gain is 8%, but is barbell shaped, there's not alot of difference between the two on average, but a lot depending upon the year. Given GDP is negative, Given that the dollar is falling, given that container shipments from the far east are still falling given the BB is an interest rate payment block buster, I would err on the side of caution and pay the one time tax burden versus assuming the stock market will continue huge annual gains. So far this year, the market return is very low for the season YTD period. good luck in your financial assumptions. |
#12
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One must also consider the “opportunity lost” when the 50gs is taken from the retirement account. $50,000 @ 5% interest over three years, for example, would earn an uncompounded $7500.
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#13
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#14
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One of the other costs to consider is if taking the money out of your IRA, and thus increasing your income for that year, will result in paying higher Medicare premiums, that is, the IRMAA costs. So, it may ultimately cost more if you take it out of an IRA. If the financial advisor is charging 2% on assets under management, then that would correspond to a $1000 annually for $50,000 AUM, the other cost to consider if taking out a loan and leaving the money in the IRA.
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#15
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Both bad options. You also didn’t state that to get a heloc there are charges up front, appraisal for 1.
1st observation, why would anybody have to ask an advisor to do this kind of thing? 2nd, the advisor has a business plan to make as much money as possible off you while your business plan is to pay less or make as much money for me as possible. 2 conflicting plans, and the advisor will always win. For this small amount, or for buying a house before yours sells, get a secured loan thru your broker, interest only, no impact to your investing options. I’ve done this for almost 20 years. When building a new house, I was the bank for draws and when I sold my house after we moved into the new house, I paid off the secured loan. You know how much loan fees are for building a home? You have a builders loan then you have a regular home loan after the house is completed. I was saving almost 5% in fees for being the bank instead of getting loans. You have a checkbook and you can write a check for a new house, a new Porsche, then have up to 10 years to pay off the interest only loan, or pay it off when you get home from the car dealer or closing company. Last edited by rsmurano; 06-29-2025 at 08:39 AM. |
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