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Hi Zev. In your post #10029 you questioned my scenario of sheltering taxable IRA income with additional mortgage interest. Sorry for the delay. Work is the curse of the drinking class. Please bear with me through the detail required to respond to your observations.

First, all financial/asset planning decisions are contextual, i.e., they become good or bad decisions relative to "the particularity of objective conditions" they are intended to address. There is no such thing as a good investment or a good investment strategy. There are only good investments/strategies for a particular person in a particular situation with a particular set of goals. That said, let me move on.

In your post you suggest that I have proposed structuring a home equity loan to offset the taxable income from an IRA/401k. You then propose some terms for that loan. First, and not to be picky, but a home equity loan at 10% simple interest is higher than what is currently available. Second, per my tirade above, I would generally recommend a HEL or HELOC in peculiar situations. My weapon of choice would generally be a 30 year fixed rate loan. Hang in there; this IS going someplace.

Consider the following assumptions, which are part of the "particularity of objective conditions".

1. Mandatory withdrawals means age 70.5
2. Life expectancy of at least 15 years.
3. Significant alternative income making IRA $ "extra" ; amount at issue: $5,000 per year(this whole discussions springs from the problem of what to do with unneeded, taxable, mandatory income)
4. 28% mrgainal federal tax bracket, 7.5% state; combined bracket at the margin: 33.4%.
5. House worth at least $100,000 owned free and clear.
6. With property taxes, charitable deductions and long term care insurance premiums, our protagonist is at or near the threshhold to switch from standard to itemized deductions.
7. Estate planning is an issue: (a) pass maximum assets to children/grandchildren; (b) minimize FET.

I encounter this profile regularly.

Possible scenario:

Take IRA income, pay taxes, invest difference ($5,000 minus $1,670 in taxes = $$3,330 to invest).

Invest in some totally tax free vehicle yielding 10% per year. Asset value after 15 years: $116,383.

Second possible scenario:

Take out a 30 year fixed rate mortgage at the current rate of 6.875%. This will yield $75,000. Monthly payment $492.70. First 12 months' interest deduction $5,131.96. Withdraw either the minimum $5,000, or the full $5,131,96. Pay principal out of pocket ($780.44).

Purchase a VUL policy with the $75,000. It will give you an immediate death benefit of $122,442. Do this by establishing a irrevocable life insurance trust with Crummey powers. Gift the $75,000 to the trust as a joint gift from both protagonist and spouse, to children/grandchildren. Not a taxable event.

Assume the policy grows at the same 10% gross rate of return. After policy costs the net growth rate will be somewhere in the 7.6% range.

After 15 years the policy will have a death benefit of app. $225,800.

Estate planning considerations: The entire $225,800 will pass to the children/grandchildren income tax free. It is also not an asset in the estate of our protagonist or the spouse. Also, the value of the house in the estate will be reduced by the mortgage balance of app $55,000. If the estate of the couple even begins to have real FET exposure you are looking at a rate of 24% on this money. That's a tax saving of at least $13,200 on the house alone. If the IRA-withdrawal investments have not been moved out of the estate the tax saving would be about $45,600.

Net result: Additional assets passed to the heirs of
at least $67,600. The figure would be higher (app. $100,000) if the IRA investments are still in the estate.

The lump sum created ($75,000) and compounded over a 15 year time period will grow to a larger future sume than a stream of payments compounding over the same time horizon, even at a higher rate of return. Back to the six functinos of a dollar: FV of 1, and FV of 1/p.

The Crummey trust as an asset passing vehicle, and the life insurance policy as a tax sheltering vehicle, are particular to this scenario. This is not a blanket endoresement of these strategies or vehicles. But in this case it produces positive results, which is the governing factor in whether or not it is an appropriate recommendation.

The operative factor is the time value of money. By leveraging the asset over 30 years, the PV cost of funds is kept at the lowest. The lump sum compounds at a greater rate than the cost of funds. Tax overlays are factored in, and the gain is anticipated.

Hope this sheds some additional light on why I sometimes recommend leveraging the house (capital asset). ...Because it works.

I welcome your insightful response and additional questions.

Be well. dharmadollars
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