Author Topic: Using HELOC to max pre-tax accounts  (Read 535 times)

Bird In Hand

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Using HELOC to max pre-tax accounts
« on: March 06, 2020, 11:55:32 AM »
This is probably an odd question.  I did see a similar question posted years ago in this forum, but it looked specific to the Canadian retirement system.  Rather than necro that one...

Is it crazy to consider using a prime-rate HELOC (currently 4.25%) to help fill up pre-tax buckets in the US?  If so, why?

Let's say someone had zero debt, a solid emergency fund, and only has enough income this year to contribute $9,500 toward the company 401k.  Would it make sense to withdraw $10k from the HELOC to max out the 401k?  The immediate benefit would be $2,200 less paid in taxes this year.  The longer term benefit would be greater potential for tax-deferred compounding to occur (earlier FI, etc.).  The short-term downside would be paying back the $10k on the HELOC, plus interest.  If one were to pretend the HELOC were a 15 year 4.25% mortgage, the monthly P&I would be about $75.  If you took the entire 15 years to pay it off, each $10k borrowed would incur a little over $3,300 in interest (with a continuous mix of current and future/inflated dollars).

Obviously this could become a trap if $10k per year were added to the HELOC indefinitely with no available income to pay it off.  Or if interest rates started to go up a lot.  But each year's $2,200 tax return (or equivalent reduction in payroll taxes) could be used to pay the minimum payment plus another $110/mo, shortening the payoff to 5 yrs.  For the scenario I have in mind, the person would use the HELOC to pad out the pre-tax funds in years where income was low or expenses were high, and then pay it down in years with higher income or lower expenses.

So other than the interest rate risk, what else am I missing?  I'm ignoring the possibility that financial hard times could lead to a loss of the house since the HELOC is technically a lien; let's imagine that this person has enough already saved in the EF and/or 401k to withdraw in an emergency in case the bank called the loan immediately.

Alternatepriorities

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Re: Using HELOC to max pre-tax accounts
« Reply #1 on: March 06, 2020, 12:24:47 PM »
Why not just use the emergency fund to front load the pretax account and the use the heloc as an emergency fund? Seems that saves you a bunch on interest and most of the risk.

Bird In Hand

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Re: Using HELOC to max pre-tax accounts
« Reply #2 on: March 06, 2020, 12:36:15 PM »
Why not just use the emergency fund to front load the pretax account and the use the heloc as an emergency fund? Seems that saves you a bunch on interest and most of the risk.

Great question!  Let's say the person has a spouse who is very uncomfortable having zero balance in the EF, but isn't scared by the < $100/mo HELOC payments.

honeyfill

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Re: Using HELOC to max pre-tax accounts
« Reply #3 on: March 06, 2020, 01:11:56 PM »
Not to hijack the thread, but you can also use a HELOC to help keep your taxable income low enough to qualify for subsidized ACA premiums.  If you are low on money in taxable accounts and have a bunch in pre tax accounts, you can borrow enough from the HELOC to make it through a extra few years until you reach Medicare age. 

Bird In Hand

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Re: Using HELOC to max pre-tax accounts
« Reply #4 on: March 06, 2020, 01:47:21 PM »
Not to hijack the thread, but you can also use a HELOC to help keep your taxable income low enough to qualify for subsidized ACA premiums.  If you are low on money in taxable accounts and have a bunch in pre tax accounts, you can borrow enough from the HELOC to make it through a extra few years until you reach Medicare age.

Totally a hijack.  But that's cool -- interesting idea there.  You could similarly use it to stay in a given tax bracket for Roth conversions, or to stay in the 0% LTCG bracket.

Back to your ACA idea, I'd probably prefer a regular HE loan (or cash-out refi if there's a mortgage) with as much $$ as I knew I'd need over the period until Medicare starts.  Rates are just so crazy-low right now.

Alternatepriorities

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Re: Using HELOC to max pre-tax accounts
« Reply #5 on: March 06, 2020, 01:56:02 PM »
Why not just use the emergency fund to front load the pretax account and the use the heloc as an emergency fund? Seems that saves you a bunch on interest and most of the risk.

Great question!  Let's say the person has a spouse who is very uncomfortable having zero balance in the EF, but isn't scared by the < $100/mo HELOC payments.

Fair enough.

I have always been and still am hesitant to borrow money for investing. If the market actually tanks over this virus thing I might finally decide it's worth the discomfort. One part your plan I'm unsure of: it would seem to me that you should plant to pay the heloc back within a year so that you can repeat the process the following year?

Bird In Hand

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Re: Using HELOC to max pre-tax accounts
« Reply #6 on: March 06, 2020, 02:19:05 PM »
I have always been and still am hesitant to borrow money for investing. If the market actually tanks over this virus thing I might finally decide it's worth the discomfort. One part your plan I'm unsure of: it would seem to me that you should plant to pay the heloc back within a year so that you can repeat the process the following year?

I would view the HELOC as something to help max-out pre-tax accounts only in years where it's needed due to income/expense constraints, not necessarily planning to use it to fund $10k worth of pre-tax each and every year.  Sort a twist on the springy debt concept, except with the added bonus of a big fat 22% tax refund on the debt incurred.  The tax refund alone could fund "minimum payments" (pretending it's a fixed term) on the loan for 2.5 yrs.

At any rate, as long as we're talking about total HELOC balances of no more than, say...as much Roth principal the person has access to (or EF, or 401k loan, etc.), the risk seems very low to me.
« Last Edit: March 06, 2020, 07:22:25 PM by Bird In Hand »

Alternatepriorities

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Re: Using HELOC to max pre-tax accounts
« Reply #7 on: March 06, 2020, 02:57:17 PM »
Yeah, it does seem pretty low risk.

I am self employed with highly variable income so I probably won't do it. This is the first year since I started this that I've been sure enough of cash flow to max out my Roth before I calculate taxes... Of course it's not turning to be quite as brilliant as it would have been to fund 2019's in March...

Last year I was successful at using my i401k to avoid the 22% bracket, but i realized after the fact that it makes a lot more sense for DW to max out her 403b first because of the way QBI is calculated.