Friday, March 11, 2005

Should I borrow to fund my 2004 Roth IRA

What am I to do when I feel "I must! I must! I must increase my Roth!" (my apologies to Judy Blume) but I don't have the cash to do it before April 15th? I consider the importance of making the contribution and I carefully weigh my options...

The Problem...A dinky Roth at my age!

About seven years ago, when they first came available, I opened a Roth IRA in the form of a $2000 CD with my bank. In Jan 2003 I moved it to a mutual fund, but I have not contributed to it since it's inception. Instead, I have focused solely on maximizing my 401(k) contributions each year. I reasoned I didn't have the "extra" money to put in a Roth, I wanted to minimize my taxes TODAY, and tax burden would be much lower in retirement.

I now know prioritizing minimizing my tax burden now may not be the best option for long-term and that it's best to "tax diversify" a retirement portfolio (using tax-deferred, tax-free and taxable accounts). It has become clear how important a Roth IRA is to meeting my retirement goals. I am 37 now, with a Roth IRA worth approximately $3000 - only 5% of my retirement portfolio - ACK!

I've wasted some valuable compounding time so I am feeling the pressure. I must make a 2004 contribution before April 15th. Using a conservative 8% avg return and a fantasy retirement date of 50, I calculated the following:
If I do not make a 2004 contribution, I start with my current $3000 balance and contribute $4000 annually until 2008. I contribute $5000 annually from 2008 forward for a total Roth balance of $116,664.00 in 2018.

If I make a 2004 contribution of $3000, I start with $6000 and making the same assumptions my Roth balance would be $124,823.00 in 2018.
That's not huge, due to the limited time involved, but that's over $5000 extra that I'd rather have! If I then leave that money untouched until I am 60 and can withdraw it without penalty, again assuming an 8% return, that difference nearly triples to over $14,500!

Aye, but the rub is that I have no cash savings with which to contribute...argh! I have paid off all my credit card debt as of last week and I am determined to begin saving 30% of my takehome pay beginning next month, but I only have $50.03 in my shiny new ING savings account.

The Solution...Borrow?
It being near tax time, the invitations to borrow are pouring in. At my new savings rate, I could have the $3000 by mid-May without a problem...but not by April 15th. Since I would only need to borrow for a short time I decided to look at my options:

  1. Checks for our home equity line (HELOC) that have an APR of 5.875% (daily periodic finance charge of 0.0161%) and the interest is tax deductible. There is no transaction fee and I could start this loan as late as 4/14. If I pay it off by 5/15 it will cost me about $15 to borrow this way (roughly $11 considering the tax implications of a 25% marginal rate, right?). It is a variable rate, but for such a short term, I'm sticking with this calculation.

  2. "Checks" from a credit card at a promotional APR of 1.99% (daily finance charge of 0.0052%). This is a fixed rate until July 31 and also appears to have no transaction fee. The offer expires at the end of the month, so I would have to start the loan on 3/31. If I pay this off by 5/15, it will cost me a little more than $7...less than half what the HELOC option costs. They will also credit me $1 for every $1000 "transferred" online instead of via the paper checks. If I can qualify for that credit (can I "transfer" to myself? My bank? Or only to another credit card account?) I break even on about day 18 and the loan will cost less than $5.

Conclusion...Good debt?
For under $8 I can make a serious investment in my future. I will also investigate whether I can use a .99% rate that I often get invitations to use (Oh Sony Card...come to my rescue!) and drop my cost to below $4. I might even be able to map out a plan using my ING account that would lessen or eradicate that cost altogether.

In addition to the small financial cost, I will also have to endure the disappointment of postponing credit card debt eradication for another 60+ days (Khaaaaaaan!), but the theoretical math doesn't lie (theoretically) so this seems like a wise choice nonetheless.

I got the OK from my better half and thumbs up from Pepper, so I'm going for it.


  1. Nice post. You definite made the right decision to borrow and contribute. The analysis is a bit off though. The difference between the two options is approximately $5,000 -- you need to take out the $3,000 more contribution you make for a fair comparison. Agree?

  2. You are cracking me up!! I can't get the modified Judy Blume phrase out of my mind.

    Two things... I would only borrow if you are really comfortably doing it (really comfortable, meaning you have no doubts that you can pay it back swiftly). I would also double-check that's there no transfer-fee, on top of the interest rate, on that credit card before you transfer the money.


  3. Thanks for catching that, PFBlog! I've updated the figures accordingly.

    frugalgirl, those are excellent points and I agree. I am taking a little bit of a risk - but paying the loan off by 5/15 is my "worst-case" scenario barring unforseen financial catastrophes. We all know those can happen at any time (and I've had my share the last 3 years) so I am not making this choice lightly :)

    And *yes* I will absolutely make sure there is no fee...I had intended to make that clear, oops!


Related Posts Plugin for WordPress, Blogger...