The short version: I'm trying to compare the total cost (including opportunity) of two methods of funding a $150k purchase, the first being a loan, the second selling some investments that would trigger some high taxes - their are 5 specific questions at the bottom, along with a table breaking down how I calculated the costs.
The long version...
I'm aware there are a multitude of questions related to when it makes sense to take out a loan vs pay for something in cash (broadly, is the interest earned > interest paid), but my question is (I believe) a little different. Before I start, I am aware I should probably just go to an accountant/financial adviser to figure this out, but it seems like the sort of thing that should be doable!
Let's pretend: I'm $150,000 cash shy (e.g., if I were to liquidate all my tax free investments, leaving just an emergency fund of cash) of buying some stuff - for the sake of argument we'll say the stuff I'm buying has no value (I don't think it matters - since the assets would have the same value regardless of where the money came from).
The decision is to take out a $150,000 home equity loan (or HELOC - keeping it as a straight loan for calculation purposes), or to withdraw money from a business margin account, which will trigger some pretty large tax consequences.
Broadly speaking, to get $150,000 cash in (my personal) hand from the business account, I'd need to sell something like $250,000 in assets - I'd pay a total of $99k tax in various places (I won't bore you with the calculations, but assume I've done some due diligence here around the deductions).
The table below indicates the line items I've thought about - on the surface, it seems like the loan is much more cost effective with a total cost of $59k and withdrawing from the business a total cost of $130k - but this feels...wrong, like I've forgotten to count something, or am double counting it. I'm aware I'm not taking inflation into account, which would act as a positive force for the loan, and a negative one for the business account - but that would seem to skew things even further in the direction of the loan.
Interestingly (or perhaps not) the conversation is broadly the same (albeit much closer - making the questions more interesting!) if I remove the business from the equation, and pretend I've got the cash sitting in a personal taxable account - in that case, it only takes $163k ($12k tax, $57k opportunity) to realise $150k in my account.
In addition to the specifics of the question, I'm mostly curious about how to think about this, because I keep finding "costs" to add the loan, and it still seems to come out miles ahead, which makes me think I've missed something.
Some specific questions:
- Is the loan just better? Stop asking questions and be done with it
- Am I totally, irredeemably wrong with my calculations?
- Am I double counting something?
- The opportunity of the loan vs business account seems quite wrong, like I'm counting a diff in one place and the total loss in the other
- The opportunity cost of the loan also already factors in the interest rate, so I'm not sure if I'm somehow double counting that?
- Is the entire difference because of triggering the tax deferral in the corporate account?
- Is this just because I've made stupid assumptions about the loan interest rate and investment returns? 5%/year seems a reasonable return for a moderate risk portfolio, the 6.5% is the split difference between the lowest advertised HELOC (I don't really believe it) rate of 4.95% and the average (according to Google) rate of a car loan of 8% - which I trust that with my house as collateral the bank would beat substantially.
As a complete aside - if any of my calculations are even remotely close to correct, it seems the cost of spending $150k, is WAY higher than $150k, maybe I shouldn't buy anything...:D
| Line item/Scenarios | HEL/HELOC | Business taxable account | Personal taxable account |
|---|---|---|---|
| Sale of investments | $0 | $250,000 | $163,000 |
| Total tax to my personal hand | $0 | $-99,500 | $-12,640 |
| Loan | $150,000 | $0 | $0 |
| Cash on hand | $0 | $150,630 | $150,359 |
| Interest cost (5y@6.5%) | $-25731 | $0 | $0 |
| Opportunity cost (5y@5%) | $-18416* | $-69,070*** | $-57,674 |
| Tax deduction cost (RRSP deduction) | $-15,000** | $0 | $0 |
| Theoretical tax diff**** | $0 | $37,363 | ~$8000 |
| Total cost | $-59,147 | $-131,207 | $-62,314 |
* I used a calculator for this - it's the monthly contribution that would otherwise have gone to savings compounding at 5% for 5 years minus the cost of the loan + interest, I don't really understand why, but this is what the "opportunity cost of a loan" calculator told me. This is what would make the biggest difference - the monthly cost of the loan (broadly what I'm not contributing to an RRSP) is ~$2900 - yielding $192k
** In addition to the reduced savings, these would have gone to an RRSP, which triggers a tax reduction - the details are boring, but basically you retain the room, but it's worth less in future years because your marginal rate has been reduced by "that years" deduction, then you apply the saved deduction too - this is a total guestimate (based on dropping ~1 tax bracket), but reasonable.
*** If I had left the $250k invested at 5% for 5 years - I just used a calculator
**** An extra wrinkle - I would eventually have to sell the assets anyway, triggering a capital gain, if I had no earned income that year (e.g., in retirement), this is the tax I would have paid
