November 23, 2017 // Debt: Your New Best Friend?
For many incorporated professionals, there is often a desire to plan for the elimination of debt as quickly as possible. For some the desire is a belief in being debt free. Others may be wanting to free up cash flow as quickly as possible. Quite often it’s because they see no better option and the decision to focus on debt elimination is never a bad thing.
Or is it?
We continue to live in a world of historically low interest rates. And for incorporated professionals, in increasingly higher tax brackets. Given this, it’s worthwhile to look at “good debt” (such as a mortgage) in a new way.
Let’s assume an incorporated professional is already taking $200,000 in salary from their company for their mortgage payments, family living and travel needs, and of course taxes. At this level of salary from their Professional Corporation they’ll pay almost $60,000 in tax.
Let’s also assume that same professional has an $800,000 mortgage and is currently paying a 3% interest rate, to be repaid over 25 years. Their required monthly payments of $3,600 per month will mean their total interest paid over the 25 years will be almost $336,000.
If they wanted repay their mortgage in 15 years instead, the professional would need to increase their monthly payments by another $1,900 for a total monthly payment of $5,500. But to do so would require them to increase their annual income from $200,000 per year to $243,000 to account for taxes. That’s an extra $20,200 per year gone to the government.
While saving $142,600 of interest with a 15 year mortgage may sound very attractive, they will have spend $303,000 of additional taxes ($20,200 per year for 15 years). This means they’re actually worse off by over $160,000.
What if they had kept the extra $43,000 in their company? After their small business taxes were paid, they would have $37,625 per year to put towards investments through the corporation. At a 4% after-tax assumed rate of return, in the same 15 years they would have over $750,000 of investments saved within their corporation. Quite a significant improvement from a debt-only focus.
There are many other reasons to focus on debt repayment plans. Maybe there’s a car loan with a high monthly payment, which can be eliminated much faster than your mortgage. Or maybe you just really aren’t comfortable with debt looming. Whatever the reason, proper planning from a fee-based advisor can make a significant difference for helping you make the decision that is best for your own needs and goals.
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