Borrowing to save
Borrowing money to save money may seem unusual, but for people who want to use the tax advantages of an individual retirement account (IRA), it can make sense in some cases.
One reason for doing this would be to get the $2,000 maximum contribution in the account early in the year, so it can earn a full year's interest. Another reason would be to get the maximum contribution deposited in the IRA every year. If an individual could only deposit $1,500 one year, they could not put in $2, 500 the next year to make up for it.
If a taxpayer in the 33 percent tax bracket paid 15 percent interest to borrow $2,000 for his IRA, his interest cost for one year is $300. But the 33 percent tax bracket reduced that to $201. Meanwhile, the IRA, with an interest rate of 10 percent, has earned $200.
While this would seem to leave the taxpayer $1 in the hole, making all the effort of borrowing seem a lot of bother, remember that now the account has $2, 200. Added to the next year's IRA deposits, the compounding effect will more than make up for that dollar.