3% savings account interest courtesy IRS

[Rapid Robert]

I don't think I've seen this proposed anywhere yet, so here goes, let me know what could go wrong.

Suppose you have an IRA balance well into the six-figure range or higher. Further, you have $30K in cash savings on which you'd like to earn more than 0.05% interest or whatever the meager rates currently are.

So, you take a $100K CARES Act coronavirus-related distribution in 2020, and you elect to pay the tax entirely in the first year, let's say $30K. You park the $100K somewhere (more on that) for 3 years, then pay it all back into the IRA. You file the amended 2020 tax return claiming a $30K refund, and the IRS pays you that plus 3% statutory interest per year. In effect, it's like a 3-year savings CD paying 3%, much better than any deal I've seen out there lately and much better than any forecast, given that the Fed intends to keep their rates rates close to zero for the foreseeable future.

This assumes the IRS interest rates won't drop below 3% (they never have in modern history).

One key is where to park the $100K for 3 years. Safest is to put it in a FDIC-insured bank account. But then, if the stock market does well, you've missed out (of course if the stock market tanks, you are that much better off). Or, you could adjust your remaining IRA investments to be more risky, to offset the cash holding. Or, you could just re-invest the $100K back into a regular brokerage account and take your chances. Gains will be taxed at cap gains rates (good), and even if there was say a 50% drop in the market, it is reasonable that you could use up a $50K LT cap loss over 15 years or less, which is much better than having a non-deductible loss in your IRA. (But you would need some short-term financing to restore the lost dollars back into your IRA at the end of 3 years, at least until you get your $30K back).

A lot of trouble for an extra $2,700? Maybe. But again, how much trouble would it be, really? Just a few online transactions.

[ATSMAN]

I am more surprised that IRS is paying 3% interest on refunds. They need to change this from "The interest rate is determined quarterly and is the federal short-term rate plus 3 percent." to just the federal short term rate when market rates are historically low.

[Lion]

You'll pay your hypothetical 30% tax rate on the $2,700 interest, reducing it to $1,890. But, more importantly, with a new administration/new Congress intent on raising taxes and increasing credits such as ACTC, EIC, etc., how good is your crystal ball re that 3% interest rate?!

[Rapid Robert]

"I am more surprised that IRS is paying 3% interest on refunds."

But this is also what they charge on underpayments of estimated tax, and late payment of balance due and penalties. If they dropped the underpayment rate along with the refund rate to near zero, who would bother making estimated payments anymore? Incidentally, this is why corporations face different interest rates for overpayments vs. underpayments, because apparently they were deliberately overpaying taxes so they could make the interest rate on the refunds (so I was told once, and it makes sense).

"reducing it to $1,890"

Maybe you wouldn't think twice about turning down an easy $1,890, but to me it's still a significant sum. Anyway, in my scenario the taxpayer is normally well below 30% marginal bracket, it is only due to the bump from $100K of income in one year that they would be up. The refund interest would probaby be taxed a lower rates in the year received. Also, not sure why you think raising taxes would have anything to do with the statutory interest rate on under/over payments. And if inflation does kick up and the rate rises, it only makes the scenairo even more beneficial.

[ATSMAN]

If they dropped the underpayment rate along with the refund rate to near zero, who would bother making estimated payments anymore?

Correct BUT they could charge a penalty at a rate that will make taxpayers comply!

[Lion]

I don't think raising taxes would necessarily have anything to do with the statutory interest rate on under/over payments, but I do think that we will see many changes by the new administration and Congress that will mean changes in our usual planning conversations with our clients.

[ATSMAN]

I don't think raising taxes would necessarily have anything to do with the statutory interest rate on under/over payments, but I do think that we will see many changes by the new administration and Congress that will mean changes in our usual planning conversations with our clients.

Correct. I see changes relatively soon with respect to CG rates for AGI above $500,000. Student loan forgiveness to a specific amount and more interest deduction. End of SALT, higher Corp tax rates etc.

It is going to be interesting when we do year end planning next year!