Should client borrow to fund SEP

[Kram BergGold]

Married couple in 25% bracket and $179k AGI spent money for tuition. If the S/E taxpayer contributes to a SEP they save like 45%. However to do this they would have to borrow the funds. They are subject to AMT so homne equtiy borrowing is not deductible.
So two questions:
Say it will take them 10 years to pay back the loan, is it worth borrowing the money?
if they borrow could it be considered investment interest?
My prejudice is too say you don't borrow to fund a retirrement account but in this case where the savings are so much I am considering changing my tune. Just looking for other opinions.

[Uncle Sam]

Borrowing to Fund SEP

I would.

Think of it like this.

They have a fixed deadline to fund the SEP to save a substantial amount of tax money now - which leaves them more current money to live on. They don't have a fixed deadline to pay back the money - all it costs is interest income over the term of the loan.

IF, and ONLY IF, your clients are disciplined enough to be responsible to pay the money back, would it be within their means to temporarily borrow the money (like a cash advance on a credit card) and when they have more cash available, pay it back as soon as possible?

And I wouldn't consider it investment interest.

[JohnH]

I've borrowed on a couple of occasions to fund my SEP. Tax deadline was approaching and I had solid receivables I knew were coming in. Didn't give it a second thought. Once the contribution window close for a given year, it slams shut permanently. No sense letting that happen.

Back in Sept 2001 I even borrowed from an insurance policy to fund the SEP for myself and an employee. (It was the only whole-life policy I ever purchased before I changed my mind about whole life vs. term). In the aftermath of 9/11/01 and with all the uncertainty going around, I needed to make a quick decision. So I accomplished two things - essentially converted the whole life policy to a term policy via the back door and deployed the funds in the Vanguard Total Stock Market Index, where they should have been all along. The plicy loan remains in place to this day, as do the funds that went into the SEP.

The other times I have borrowed to fund the SEP, I generally repaid the borrowing fairly quickly. But even if the repayment stretches out over some period of time, it's probably still worthwhile unless the client is a total flake when it comes to money management. None of the above is to say that your client should do what I did - I'm just sharing personal experience and rationale as it relates to your clients' situation.

Even if your client takes 10 year to repay the loan, this is still advisable IMO. Assuming a reasonable interest rate on the loan and assuming the underlying investment the SEP goes into performs well or average, they will be OK no matter how long they take to repay the loan. I'm sure there are ways to construct scenarios for them to get upside down somehow, but under normal circumstances they will be OK regardless of the repayment period.

[taxxcpa]

I would make my decision by analyzing the total tax savings vs the total cost of the loan including interest. Would the interest qualify as a deduction? That would also be a factor.

Also to be considered is that the tax is not really "saved." It is deferred. Another consideration would be that tax rates could increase in the future to enable the government to avoid bankruptcy. Your income in retirement might not be any less than when you worked.

I retired a number of years ago, and, without considering my income from tax and accounting work, my income is now higher, due to investment income, than when I was working--but my tax bracket is lower since I retired before the Bush tax cuts.

It is unlikely that anyone retiring now could expect tax rates to drop as much as they did when I retired.

[ChEAr$]

Married couple in 25% bracket and $179k AGI spent money for tuition. If the S/E taxpayer contributes to a SEP they save like 45%. However to do this they would have to borrow the funds. They are subject to AMT so homne equtiy borrowing is not deductible.
So two questions:
Say it will take them 10 years to pay back the loan, is it worth borrowing the money?
if they borrow could it be considered investment interest?
My prejudice is too say you don't borrow to fund a retirrement account but in this case where the savings are so much I am considering changing my tune. Just looking for other opinions.

How would savings be 45%? 45% of what? With a federal bracket 25%, is MA bracket 20%?

[Gary2]

How would savings be 45%? 45% of what? With a federal bracket 25%, is MA bracket 20%?

With a SEP, the bulk of the contribution is employer contribution, so it avoids the SE tax as well as the income tax.

For what it's worth, the base MA rate is 5.3% in 2011, going down to 5.25% in 2012. Certain types of capital gains are taxed differently, at either 12% or an effective 6% (the latter due to a 50% deduction on a subset of the 12% gains).

[JohnH]

I'm guessing the SEP contribution lowers AGI below the threshold for phaseout of the American Opportunity Credit. With that percentage of tax savings vs payout, refundable credits have to be in play.

If so, then this is a slam dunk.

[Kram BergGold]

John H is correct

Helps with AOC and maybe AMT.