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”
I’m not doing anything new here, of course. Households with an abundance of assets have used debt as a tool since time immemorial. Real Estate Investors do it, Presidents do it, and now we do it.
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%
- Self-employment
- 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
Summary
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.
How would you go about doing this with non-real estate assets? I see the huge advantages of renting and plan to never own any real estate again.
Are you recommending margin loans to fund retirement spending, rather than selling the asset? Looking forward to a follow up article with more details…
I’m not recommending anything – I’m sharing what I am doing and why. Debt is debt – mortgage, margin, whatever, its debt.
It largely depends on the interest rate one pays to borrow (margin)… That rate is currently well below the above tax examples but it’s well above zero and depending on the equity performance it can start to eat into principle. That and depending on how much one uses there is always risk of margin calls in very extreme market conditions which happen from time to time. I do use margin from time to time but have always paid it off. Never comfortable with it
Sure. Do the math.
did you go w an asset based lender or did u just use your blog and div income to qualify..no income and finding it hard to get a loan on my place in bellevue washington
Our loan qualification was all of the above (I provided assets and SE income, both, but most of their attention was on the assets.)
Rocket Mortgage will do asset backed loans with discounts for Schwab customers
Getting a Mortgage Without a Job
How disingenuous.
ok
Debt is debt but it has different characteristics which can be important on the downside. For example, California’s anti-deficiency protections will prevent your mortgage lender from ever coming after you personally. The same cannot be said for other forms of debt.
Sure.
What is the situation where you see a financially independent person using debt for efficiency on marginal spending walking away from their home?
Eli, I am curious why you see “huge advantages of renting”? Can you elaborate? Or maybe write an article yourself? ;)
Sergei, no need to write a new article. This one from a couple of years ago does a great job:
https://www.gocurrycracker.com/renters-for-life/
I thought this was going to be a margin loan post when I first saw the title … oops. Margin loans are interesting but my fear is what happens in a flash crash… Do you get liquidated before the prices get reset to normal, or do you get a grace period? I guess it depends on your broker, but its a scary thing to think about regardless
If you go wild with maximum leverage, things could get dicey in a crash, sure. Similar to if you get really into meth or heroin.
Let’s say maintenance margin is 30% (legal minimum 25%) – if you have $10k and the value of all securities minus margin in your brokerage account drops below $3k, you would have to input cash / sell securities. If you have 2-3x leverage, that can happen with a market drop of just 20% or so. If you are 20:1 leverage, you would need a 70% portfolio drop.
This is borrowing only ~5% of the portfolio, which is perfectly reasonable since debt is covering only your marginal spending. (If following 4% rule (~$40k/year budget on $1kk) then other sources provide $30-$35k/year and the debt covers the rest, so $50k debt would cover you for up to 10 years.)
I’m curious how you calculated the 13% marginal rate for ACA subsidies? This is a topic I need to dive into soon.
There are a couple charts in this post that show how the ACA functions like a tax. Between 150% and 300% FPL it is ~13% (premiums increase by $0.13 for every $1 in income.)
https://www.gocurrycracker.com/american-rescue-plan-act-of-2021/
If/when the ARP enhancements to the ACA expire at end of this year the tax rate goes up a bit.
I explored this a lot in these 2 posts:
Obamacare Optimization in Early Retirement
Obamacare Optimization vs Tax Minimization
Very helpful – thanks. I’d likely be managing to between 300-400% FPL so it looks like the marginal rate in that range is a bit higher at ~16-17% based on the chart in your ARPA post.
So, aside from the mortgage, are you considering personal lines of credit, HELOCs, what else?
I just sized the mortgage to cover what I thought we would need. Next in line for me would be to replace the mortgage with margin loans at 1.x% although that is unlikely to hold as rates rise… still a big delta to current 2.75% rate. Next in line after that is probably to refinance the existing mortgage.
I approve this. Smart…
Hi GCC – Where you keeping the mortgage cash? Reinvesting it or do you have more of a cash cushion now.
Also thanks for all you writings over the years – we cash out refi in 2021 and it’s been much to our financial and peace of mind benefit (diversification of asset classes – we invested the proceeds in VTI).
I reinvested most of it inline with the rest of our portfolio (VTI/VXUS/bonds.) The rest is in cash in our brokerage account.
Details: Investing Our Mortgage – An Experiment
Since we are both 68 the clock is ticking on RMDs from our retirement accounts, so we won’t get the big bang for the bucks of years like you will. But we still use debt when it is in our interest, which is why I keep a LOC open with our bank. For example, we have a new truck scheduled for start of production in Feb that will hopefully be to us sometime in later March. If the manufacturer offers no or low cost financing we’ll take advantage of it, otherwise I will use the LOC to stave off using cash or CGs for as long as possible. Smart on your part to use this strategy; wish I went strong for it years ago with things like a mortgage, since we paid off our houses quickly.
This is probably a good strategy for age 50-65. Once on Medicare the ACA tax goes away and other sources of cash look more interesting.
I was thinking similar with the car purchase, I had the cash set aside but the rates were too good to pass up.
It seems a little strange to compare the cost of borrowing with the (tax) cost of selling. You are going to sell sooner or later (unless you plan to die rich?). Whether you pay taxes sooner or later doesn’t change anything (assuming, yes big if, your effective tax rate stays the same). The real factor is the opportunity cost of selling early (i.e. no future growth on the tax-free portion of the assets you spend) or not. It seems to me that a more proper comparison would be the borrowing rate vs. the expected rate of return of your financial assets.
>You are going to sell sooner or later
No. Buy, Borrow, Die.
>Whether you pay taxes sooner or later doesn’t change anything
It does – the $ you pay in taxes can no longer grow. Future tax rate without ACA will be lower than today.
Proper analysis
7-10% > 2.75% = never sell. Now, where does the money to fund your lifestyle come from? How much does that cost?
Future tax rate is sheer speculation. Nobody can predict what the tax code will look like 20 years from now. But this might very well go upwards in one way or another…
Now I must admit I thought you were being facetious about the borrow-till-I-die statement. If that is truly the plan, then I agree, this changes the equation.
Your write-up seemed solely focused on you reaching 59 though, and I hope you plan to die a few decades later than that… Maybe you could elaborate on how you plan to keep borrowing till you die, then?
No speculation – at age 65 I’ll be on Medicare. The ~13% ACA tax goes away. At that point in time there will be a standard deduction and marginal tax brackets with progressive rates, with low-income households such as ours paying relatively little in tax. You can’t squeeze blood from a stone, so they say.
Between today and the age of death our assets will increase in value. Ergo the amount banks will lend will also increase. See the bullet point, “repeat at leisure.”
At age 59.5 we will get additional options. Maybe unrestricted access to IRAs (including Roth earnings) will change debt’s allure, I dunno, but it isn’t practical to plan that far in advance. It will depend on what interest rates look like at that time, whether markets are at high or low valuation, inflation rates, etc… At this stage of life and market conditions, debt looks pretty sweet.
Plus if you negotiate for the right car at the right time you can get it for a price for cash that’s lower than what they’ll give you if they finance it for 0%. Caveats are it being a more regular car buying environment and you are willing to search out the best deal and not be fixated with the car you feel you must have. Get the car cheaper because you already have money on hand due to your LOC. I think I know how I’ll pay for my next car.
I’m struggling with how you’re calculating the interest cost of your mortgage. Sure, it’s a 2.5% loan but with the way it’s front loaded on the payments, your effective annual cost is way higher than 2.5%. Help me out with this please.
$1000 * 2.75% = $27.50. That math is the same in Year 1 or Year 30.
What changes over time via the amortization table is how many thousands of dollars you are paying interest on, much in the beginning / little at the end.
That changes because of the pay down in principal, which is just moving money from one pocket to another – If I have $x in my savings account and I give it to the mortgage holder for principal reduction, my net worth is the same before and after. Although in the latter case the bank will now lend those funds back to me.
This is true as long as you have the cash flow – the bank wants that monthly payment no matter what. This is where interest only loans can be interesting
Thanks for this. Although I’ve read about the concept before, I like the concise way you have presented it.
For readers of a certain age ( and we don’t always know that age) there is the concern of one or the significant other, needing a nursing home.
Cost for such is ridiculously exorbitant and most people rely on Medicaid to cover it.
Laws vary by state. In most, ( maybe all) unless protected, Medicare goes after the assets to get back money. Then you’re losing, pass the wealth on tax free benefit planned.
Typical ways around it are to place the house in a life estate or a particular type of trust.
There are typically look back periods of usually 5-7 years. Meaning if someone needs a nursing home tomorrow they would have needed to plan for it 5-7 years earlier for best financial effect.
With the house protected by one of these options the house is protected by Medicaid taking it.
Again, it’s state by state with the rules. You can met with an elder care lawyer to discuss. They can also help to protect other assets.
Typically first meeting is free and can be quite informative. Believe going general cost for setup is $8k- $15k, depending where you are in the country and complexity due to assets that need to be protected.
Mr Market is still purring along, and stands to average out at 7-8%, and I can get a Heloc and covert into a Mortgage at 1.4% right now, its a no brainer. Borrow at 1.4, invest at 7. We have a thing called a TFSA, Tax Free Saving Account, and mine and the wifes has tons of room, about 150K worth. Oh, and free health care… you should move to Canada… lots of parking.
Canada is too cold for me in my old age (I grew up at a latitude a bit north of Toronto.) 1.4% is pretty sweet
Impressive. Cheap, fixed rate debt is fantastic.
Can’t do this in my market since it is currently 7% borrowing rate, variable rate, and going up probably back to around 10%.
But for developed markets that do fixed rates that’s awesome, especially with property that isn’t likely to plummet in value.
In your case, the margin loans look great, would you take advantage at the 1.5% for now, and then just pay it off using mortgage debt later should rates increase past the mortgage fixed rate?
Are there any income requirements from the bank to get the loan?
Just assets
Getting a Mortgage Without a Job
I just settled for the fixed 2.75% long-term debt rather than try to get the lowest possible rate. Now I don’t really need to think about it for a decade or so…
If the margin rates are increasing then the mortgage rate will go up as well.
If you die in debt, do not the creditors get a chance to collect on your estate assets before you pass it onto your children?
You don’t die in debt, you die with debt. That debt is paid off at death, yes. Your heirs receive more $ than without.
Debt is needed for big items but some people over do the amount of debt.
Don’t you still need to sell assets to service the monthly debt payments though?
Potentially, yes. For example, we borrowed $250k which has a monthly payment of ~$1k. That $12k/year has to come from somewhere, but is substantially less than the alternative.
I’m not spending all $250k this year, of course, and a bunch of that has been reinvested. I’ll sell a small piece of those investments next year for minimal tax, and that will fund part of our 2023 cost of living along with the debt repayment.
Hi GCC,
Fantastic article and very unique and simple way to look at a few key decisions. Quick add-on question. Does a cash windfall once you are FIRE work similar to the loan? Don’t invest, leave in cash, spend down for several years and keep earning the ACA subsidies. At a value of $20K per year, you would need the equivalent of $500K earning 4%. Right?
Not really similar, no. A windfall increases your net worth, debt doesn’t change your net worth at all (net negative after interest payments.)
In regards to taxable income though, yes, cash would have no impact on your AGI or ACA premiums.
Thanks GCC.
Makes sense. I was referring to managing your taxable income.
Oh, yeah cash helps with managing taxable income / cash flow. Other ZeroAGI spending cash can come from Roth contributions, seasoned Roth conversions, stock sales at full basis (due to recent cap gain harvesting and/or down market), HSA withdrawals for qualified medical expenses, etc…
We have thought about taking on either mortgage or margin debt to help tide us over til 59.5. So far we haven’t.
Other than our $3500 appliances purchase on a zero interest credit card last year to avoid realizing more income last year. FAFSA is driving that train more than taxes or ACA.
I am not sure that in our case that SEPP might be better than debt since it looks like our state is probably going to make retirement income state tax free and after the standard deduction and AOTC we should have little to no federal liability.
So far we are just playing it by ear.
Great article GCC, I agree with all of it. I enjoyed your comparison of the borrowing costs from your mortgage and other alternatives.