Strategy to use a home-equity loan to maximize a roth 401k/roth IRA to shelter cap ga

Factual Questions
1

I was thinking up the following strategy to shelter the earnings on investment funds and wanted to see what other people thought, and insight others may have. Assuming one qualifies for a Roth IRA, has a Roth 401k option, and can make the home equity loan payment or would have contributed that loan payment amount to retirement savings anyways:

  • Taking a home equity loan out (family home that’s already paid off) for the amount of say $100k.
  • Put the money into an investment vehicle that (after taxes on dividends/interest/cap gains) will hopefully break even, or come close to, the loan interest plus inflation.
  • Using this loan to maximize my Roth IRA and Roth 401k contributions over the next five years. Or you can say to supplement my living expenses as the roth 401k contributions come out of the paycheck.

Ideas behind this:

  • The roth 401k has more limitations to withdrawals than a Roth IRA but can be rolled over into a Roth IRA if I ever leave the company or get fired. From what I’ve read: The contribution portion have already paid a tax, will be treated as conversion funds that have paid taxes and will also be allowed to be withdrawn anytime without taxes or penalties. Is this correct?

  • The key to what I’m thinking is the fact that Roth IRAs distribute contributions first, then conversion funds, and earnings last. If Roth 401k contributions rolled into a Roth IRA truly can be pulled out at anytime without penalty or taxes. So all earnings on this large influx of investment funds will be sheltered as the last to come out if the money is ever pulled out in emergency, sheltering it from any taxes today while keeping the contribution portions somewhat accessible.

  • a $100k home equity loan at a 15yr fixed can be estimated to have a payment of $900/mo ($100k @ 7%, 15yrs). If one were to instead fund an IRA and 401k at $900/mo, they would only amass $54k of contributions by the end of 5 years vs leveraging home equity to get it up front and spread it over 15 years of payments. And those 54k of contributions added monthly will have an average time invested that is much lower than say having 100k put in up front (though it will take 5 years to fully get those funds into tax sheltered roth accounts, they will incur taxes on gains until then).

and lastly misc other points:

  • There are relatively safe/less volatile options in roth IRA/401k plans if one is afraid of market volatility. This still can shelter earnings on bonds/treasuries.

  • The possibility that the interest on the home equity loan can be deductible if you itemize (I read in a tax book that $100k was the limit for home equity loans, hence why this number is used). I see this as a extra bonus or perk if it favors you, but not a key point of this approach.

  • This idea does assume that your salary will rise at least in respect to inflation over the 15 year period of the loan, so your fixed mortgage payment of say $900 will become easier on your paycheck as the years go on.

  • If worst comes to worst and one gets fired, leaving a company should mean one can access the roth 401k funds and roll it over into a roth IRA, therefore allowing the possibility to live off those funds, or to simply pay off the home equity loan.

Your thoughts, suggestions, issues with the idea?

2

Is the interest on a home equity loan tax deductible like a mortgage?

3

Most of the time, yes.

4

It’s certainly an option. Not necessarily one I’d take, but certainly there could be advantages. We have done something sort of similar - not specifically using a line of credit to fund our 401(k), but using an inheritance to cover some of our living expenses, thereby allowing us to max out the 401(k). In theory we could have used that to pay down the mortgage some (though it’s a low rate fixed loan, so it wouldn’t make any short-term difference in the cash flow).

The advantages we see are: obviously, we’ve got more money socked away for retirement - AND, since the 401(k) contributions make such a huge dent in our income, we don’t lose out on some of those deductions/credits that phase out when your income grows high enough. Also, doing the 401(k) lowers our income enough that we can still contribute to our Roth IRAs. Those sort of things would be reasons why your scheme might be worth considering.

FWIW, The less volatile options are not likely to bring in better returns than your home equity rate.

There are certainly financial advisers who recommend maintaining a mortgage always, freeing up that cash for other investments. You’re proposing something similar (obtaining a mortgage, rather than continuing to hold one).

I’d suggest doing some modelling of what your cash flow would look like, and your 401(k) balance also, after a few years of doing this. Factor in the tax savings by reducing your taxable income and by increasing your deductions.