Pay off debt with Roth

[gbnivy]

I have a business credit line ($30,000 debt with a 6.75% interest rate) that I manage to pay $500 per month on.  I also have a Roth IRA with a $30,000 market value and I am currently not making any contributions to it.  I can withdrawal the entire Roth balance with no penalties.  I am wondering if it would be a good idea to liquidate the Roth and pay off the credit line, and then contribute $500 monthly back to the Roth?  Thanks to the group for your thoughts. 

[l2jperry]

There are others it seems would be better suited to give advice on here, but to me, I would liquidate the Roth and pay off the debt. You would have to be getting a pretty awesome return to beat the interest on the debt to create more wealth for yourself. So IMO, pay off the debt, start building on the Roth again with the 500 a month, and you'll even get one month off because you can only contribute max $5500 a year .

[Kshartle]

The interest is tax deductible so the after-tax return on paying it off is not very compelling (probably around than 5%). You're losing the opportunity to beat that after-tax return by a large margin over the coming years. Even the HBPP, which I consider less than ideal at the moment because of the huge bond allocation still has managed to average 9% returns or so for decades. Since that would be tax-free it blows out the return on paying off the debt.

Keep paying off the debt and don't touch that IRA man, you're going to need that IRA money down the road.

[gbnivy]

I think your comment about the emotions is accurate.  The net after tax deduction interest cost is about 5% annually, and I believe the HBPP will out perform that over time.  It is the emotional energy I exert frequently about the debt (debt is not good) itself that is taxing.  Thanks for your comment.  GBNIVY

[Kshartle]

Think long and hard about it man......it's so precious to have that roth money growing tax-free year after year. You will probably be so grateful if you just hang in there and keep paying $500 a month and leave those investments alone. The emotional decision is rarely the right one when it comes to money. It's perfectly natural to not want to have debts (well...for some debt is natural). If it's giving you ulcers though then it's not worth it, pay it off.

One thing that separates wealthy people from poor is being smart about their debt, particularly business debt, they embrace it as a means to finance assets and reduce taxes.

You could always split the difference....it certainly doesn't have to be all or nothing. Maybe there is a number...20k, 15k that you're comfortable keeping. Maybe you can refi it or transfer to a zero or low balance card if you just reduce it a little.

So many better options than completely blowing up your TAX-FREE roth.........

[mortalpawn]

I would not do it.  If you can withdraw the Roth then you have probably already reached 59-1/2, so you probably have a finite number of years to continue to contribute to a Roth, and it is a tax free account.

So lets look at some scenarios:
1) You liquidate the roth, and manage to come into some money (i.e. the business takes off, or a rich uncle dies).  Now you are in a high tax bracket, have no deduction from the loan, and have no time to replenish the roth, or your income may even push you over the limit to contribute to the roth.
2) You don't liquidate the roth, and manage to come into some money.  You're in a higher bracket, but you still have the tax deduction from the loan and you have your roth which is growing tax free, and can be withdrawn as needed (tax free) for retirement.  It also has no mandatory distributions like a regular IRA would.
3) In either of the above scenarios, holding off still seems better.  If you get to the point at any time where you really need to pay off the loan, you can still do so from the roth (which has grown tax free!), plus you get the interest deduction from the loan every year off your taxes.

Even in a 25% tax bracket (which starts at 36K) your interest rate is discounted by your tax rate, which could higher than 38% (25% income plus 13.6% combined Social Security and Medicare for a small business owner) - to which you could also add your state tax rate.  Depending on the state, you are probably looking at a 44% tax rate on your business income.

So the question is not really whether you can do better than 6.75% but instead whether you can do a bit better than 4% on your roth investment?  When you also add in the fact that the roth grows tax free, has no taxes on withdrawal, and almost impossible for you to replace at this point I think keeping the loan makes a lot of sense.

[gbnivy]

Excellent points ...Thanks.

[moda0306]

Think long and hard about it man......it's so precious to have that roth money growing tax-free year after year. You will probably be so grateful if you just hang in there and keep paying $500 a month and leave those investments alone. The emotional decision is rarely the right one when it comes to money. It's perfectly natural to not want to have debts (well...for some debt is natural). If it's giving you ulcers though then it's not worth it, pay it off.

One thing that separates wealthy people from poor is being smart about their debt, particularly business debt, they embrace it as a means to finance assets and reduce taxes.

You could always split the difference....it certainly doesn't have to be all or nothing. Maybe there is a number...20k, 15k that you're comfortable keeping. Maybe you can refi it or transfer to a zero or low balance card if you just reduce it a little.

So many better options than completely blowing up your TAX-FREE roth.........

+100

Don't count on this happening again, K!

[Kshartle]

Think long and hard about it man......it's so precious to have that roth money growing tax-free year after year. You will probably be so grateful if you just hang in there and keep paying $500 a month and leave those investments alone. The emotional decision is rarely the right one when it comes to money. It's perfectly natural to not want to have debts (well...for some debt is natural). If it's giving you ulcers though then it's not worth it, pay it off.

One thing that separates wealthy people from poor is being smart about their debt, particularly business debt, they embrace it as a means to finance assets and reduce taxes.

You could always split the difference....it certainly doesn't have to be all or nothing. Maybe there is a number...20k, 15k that you're comfortable keeping. Maybe you can refi it or transfer to a zero or low balance card if you just reduce it a little.

So many better options than completely blowing up your TAX-FREE roth.........

+100

Don't count on this happening again, K!

hahah! listen.....I will not be holding my breath!

[edsanville]

I would not do it.  If you can withdraw the Roth then you have probably already reached 59-1/2, so you probably have a finite number of years to continue to contribute to a Roth, and it is a tax free account.

I was under the impression that you could withdraw your Roth principal at any time, because it has already been taxed.  Isn't that the point of the Roth IRA as opposed to the Traditional IRA?

[Kshartle]

I would not do it.  If you can withdraw the Roth then you have probably already reached 59-1/2, so you probably have a finite number of years to continue to contribute to a Roth, and it is a tax free account.

I was under the impression that you could withdraw your Roth principal at any time, because it has already been taxed.  Isn't that the point of the Roth IRA as opposed to the Traditional IRA?

There are penalties for withdrawing unless certain circumstances are met.

It's quite different from the trad IRA....it's after-tax money and all gains are not subject to tax.

[moda0306]

I would not do it.  If you can withdraw the Roth then you have probably already reached 59-1/2, so you probably have a finite number of years to continue to contribute to a Roth, and it is a tax free account.

I was under the impression that you could withdraw your Roth principal at any time, because it has already been taxed.  Isn't that the point of the Roth IRA as opposed to the Traditional IRA?

There are penalties for withdrawing unless certain circumstances are met.

It's quite different from the trad IRA....it's after-tax money and all gains are not subject to tax.

Nope.

Even though they call it a non-qualified distribution, you can take out Roth basis tax/penalty-free.

As long as it was an original contribution and not a conversion, in which case the 5-year rule applies.

[edsanville]

I was under the impression that you could withdraw your Roth principal at any time, because it has already been taxed.  Isn't that the point of the Roth IRA as opposed to the Traditional IRA?

There are penalties for withdrawing unless certain circumstances are met.

It's quite different from the trad IRA....it's after-tax money and all gains are not subject to tax.

Nope.

Even though they call it a non-qualified distribution, you can take out Roth basis tax/penalty-free.

As long as it was an original contribution and not a conversion, in which case the 5-year rule applies.

That's what I thought.

[Kshartle]

Yes my mistake, I didn't read closely. The contributions can be withdrawn without penalty. Thanks for clarifying my mistake Moda.

[Kshartle]

Yes my mistake, I didn't read closely. The contributions can be withdrawn without penalty. Thanks for clarifying my mistake Moda. I was focused on the statement about what makes them dissimilar from the trad IRA.

[edsanville]

Yes my mistake, I didn't read closely. The contributions can be withdrawn without penalty. Thanks for clarifying my mistake Moda.

Yes, I'm glad we clarified this, because I've often told friends that there's no disadvantage to contributing to a Roth, since you can take the principle out if you need it later.

[Rien]

My standard reply to questions like these is always: Do whatever makes you sleep well.
There are ever more indications that a good nights sleep will do wonders for your physical and emotional health.

What good is big bank balance when you are too ill to enjoy it?

[moda0306]

My standard reply to questions like these is always: Do whatever makes you sleep well.
There are ever more indications that a good nights sleep will do wonders for your physical and emotional health.

What good is big bank balance when you are too ill to enjoy it?

I truly agree with this, with one observation:

Way too many people stick their head in the sand to one risk or another because it feels better to just make a decision based on limited perspective.

In any world where I can't make my investments earn 5%, I'm probably just-as if not more at-risk of a liquidity crisis.  Handling debt effectively is important on the acquisition side AND the pay-down side, and not just to grow wealth... it helps us protect it as well, if used properly.

I do know people that put themselves in quite a pinch by paying down a debt too aggressively and hitting a cash-flow crisis.

So I guess, unless someone has mentioned this, it begs the question, how many years/months of living expenses do you have saved up, and how stable is your income, AND AND AND do you have adequate insurance planning done?  Disability (group and individual supplement)?  Life? Health?  Long-term Care?  Liability?

[smurff]

If you have spare cash outside the ROTH, or have some miscellaneous things around the house or the business that you can sell for cash, or have a spare car or two that you can sell, it's better to do that than dip into the IRA to pay off the business debt.  One way to make debt less stressful is to make a game out of finding creative ways to pay it off--and then actually doing them.

In addition to the reasons others have given for keeping the Roth, your IRA assets--whether ROTH or traditional--are protected from bankruptcy and other "involuntary claims".  As in, your bank decides to seize money from you while in the midst of a dispute with them--they can't do that with IRA assets, but they can get away with doing it to your checking or savings account.  Bankruptcy is both state and federal, so the protected amount varies by state.  (The same protection applies to 401K and other qualified retirement accounts.)  I've seen $1 million as a common max, but in some states it's higher.  It's one reason athletes pile as much as they can into pensions, IRAs, and other retirement plans-it helps make them judgement-proof.

So  As tempting as it is to take money out, it's best to protect your IRA by leaving it alone.

Kshartle and Moda make good points (and to witness Moda and Kshartle agree on anything is priceless!), and there is a lot to say for doing that which keeps your stress levels down whatever advice seems best from a financial standpoint, and considering steps that are not all-or-nothing.  You can also do some of everything, including taking a tiny amount from the IRA to pay down the debt.

If you were to reduce your expenses, you could apply that newfound money to paying off the debt.  Two additional suggestions for paying off debt faster:

1.  Increase the payoff amount.  You said it's $500 per month right now, but stepping up to $550 or more can reduce the time and overall amount of the payoff without straining the budget.  (I'm jostling a Kindle on my knees to type this, so I'll leave it to someone else to calculate the reduction in time by increasing the payment.)

2.  Increase your sales.  If you were to increase the income from your business without having to increase your fixed costs, you could pay off the debt faster.  There are a host of easy techniques for increasing revenues from current customers, as well as for bringing in New customers, just google, "quick ways to increase sales" or something like that.

[Kshartle]

Kshartle and Moda make good points (and to witness Moda and Kshartle agree on anything is priceless!)

Did you notice where Gumby and I agreed about bitcoin?

Doodle....what is your favorite color?