Debt has been called many interesting things… concrete shoes, shackles for the middle class, the greatest burden… there were many years in my own life where I was terrified of debt.
But when used wisely it can be an incredibly powerful tool. So powerful in fact, it is how I plan to fund much of our cost of living for the next decade.
“Buy, Borrow, Die”
Related: See the WSJ article (paywall’d): Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth
The core idea is that borrowing is the most cost efficient option to access spending money, and then of course you still have complete control of the underlying asset.
Since you don’t sell any assets, you don’t pay taxes. And when you eventually get around to dying, the government will pass all of those asset to your heirs with stepped-up basis and no tax whatsoever. (Hmm, I wonder who wrote those tax laws.)
Is it really better to borrow?
Borrow or Sell
We recently borrowed a big chunk of money in the form of a mortgage. This will be a vital portion of our spending money between now and age 59.5.
It’s not without cost – for every thousand dollars of debt we will pay $27.50 in interest per year, ignoring principal pay down – equivalent to a 2.75% annual tax…
Which, compared to some of the alternatives:
- early withdrawal from IRA with penalty
- marginal tax rate: 10% penalty + 12% federal tax + 13% ACA premium subsidy reduction + 4% California State = 39%
- SEPP withdrawals
- marginal tax rate: 12% federal tax + 13% ACA premium subsidy reduction + 4% California State = 29%
- marginal tax rate: 15.3% SE taxes + 12% federal tax + 13% ACA premium subsidy reduction + 4% California State = 44.3%
- Long-term capital gains (stock purchased in 2007)
- marginal tax rate: 0% federal tax + 13% ACA premium subsidy reduction + 4% California = 17% marginal tax
- $1000 sale = $700 capital gain – effective tax on $1000 sale = 11.9%
- Roth contributions and Seasoned Roth Conversions (limited)
- marginal tax rate: 0%
Overall, withdrawing from retirement accounts is tax prohibitive and self-employment even more so.
Selling highly appreciated shares is not so bad, although we can borrow for 5 years before things even out on the expense side… except that in the borrowing case we still get dividends and any additional appreciation. Current yield on SP500 is about 1.5% and in theory the stock market will return more than an additional 1.25% per year, and then our kids get those assets down the road.
Bridging the Gap
How to fund retirement before you hit age 59.5 is a frequent question – it is certainly one of the things I spend the most time on with consulting clients.
For us in our new US life it looks much like this:
- Get income from dividends and self-employment (until I get bored with it.)
- Be smart about the big expenses – housing & health insurance (e.g. The Obamacare Tick-Tock.)
- Have low-appreciation shares to tap by harvesting gains before entering the US (done)
- Use sweet sweet debt to fill the gaps
- Use some now for immediate spending
- Invest some for additional dividends and long-term capital gains (with minimal appreciation, 3-5 years.)
- Repeat at leisure
For those with assets, debt can be a powerful tool, making it extremely efficient to get liquid cash. It isn’t even a contest, really – borrowing is the cheapest and easiest option, while also allowing for complete control over the underlying assets.
That’s why when it comes to funding our lives between now and age 59.5, a healthy percentage will come from debt.