I am considering a very risky tax strategy that would make Dave Ramsey’s head explode, and I am not too sure many other financial experts would be on board either. The benefit is huge, but the risks are even larger. Here is why I am considering doing a credit card balance transfer to take an IRA tax deduction, what you need to know about the risks, and how to know when it is a strategy you should consider.
The benefits of an IRA tax deduction
We will start by explaining what an IRA tax deduction is. IRA stands for Individual Retirement Account and it is a retirement account for people who don’t have 401ks through their employer. The amount of money you put into an IRA is tax deductible with a maximum contribution of $5,500 per year for people under 50 years old and $1,000 higher for people over 50. A married couple who each do not have access to a 401k account are allowed to each contribute $5,500 for a total of $11,000 if they are under 50.
There is a strange quirk in the tax law that says if you make an IRA contribution by April 15th of this year, then you can claim the deduction on last years tax return. So if you are a procrastinator and file your taxes on April 15, you can make your IRA contribution the same day and get your extra large tax refund immediately.
Let’s assume you are in the 25% tax bracket for your federal taxes and have a marginal tax rate of 5% in state taxes. In this case you would have a combined marginal tax rate of 30%.. So if you were to contribute 11,000 to your IRA your tax refund would go up a whopping $3,300. Getting $11,000 in investment funds for a net cost of $7,700 is quite a deal. So good that maybe, just maybe, it is worth going into debt for.
Is $3,300 worth doing a balance transfer for?
The only problem with the IRA tax deduction is that you have to have the cash to put into your IRA account. I have saved money for retirement every year for the last 20 years, since I was 19 years old. In 2016 a combination of not having a 401k plan, having to come up with a down payment on a house, and major medical expenses not covered by insurance meant for the first time in 20 years I didn’t put any money into a retirement account. This bothered me.
I was opening my junk mail earlier this week and I found one of my credit cards had offered an unusually good balance transfer offer of 0% for 14 months with only a 1% balance transfer fee. This was such a good deal I was almost disappointed I didn’t need to do a balance transfer.
That is when I thought of the check I am going to have to write to the IRS here in a few weeks and realised that not only could I put money into a retirement account, I could also turn my IRS payment into a large refund. My credit card allows me to balance transfer straight to my checking account so I would transfer the money to the checking account and then use the money to contribute $5,500 into my wife’s IRA and $5,500 into mine.
I want to be absolutely clear about this. This is a very risky strategy. In about a year the 0% interest rate will expire and the interest rates become HUGE. Balance transfers are a trap and one missed step will get you caught. If you can’t follow all of the steps precisely then this isn’t something you want to get mixed up in. Your better off not taking the IRA deduction so just save your money and take it next year with money out of your savings account.
The first thing you need to do is make sure there is no balance on the card you are going to use. If you have some money on a card at 0% and some money at a higher rate guess which part of your balance do you think your bank will apply all your payments to? If you have any money not at 0%, your bank will kill you in interest. That means start with a zero balance, don’t make any purchases on this card until the balance transfer is paid off, don’t carry the card around with you, and make sure there are no automatic payments set up on the card.
For the next year you have to make the minimum payments on time or the 0% interest rate disappears and your rate becomes HUGE. If there is a chance you will be late on one of your minimum payments don’t take a balance transfer. This isn’t the right deal for you.
The next thing you need to do is mark on your calendar when your 0% rate expires and pay the entire balance off before that date. I pay mine off a month early, just to be extra safe. Of course, you could just do another balance transfer from another card and repeat the whole process, but this is an even riskier move I won’t get into.
The IRA tax deduction is a great deal and can save a married couple up to $3,300. The deal is so good there are very limited situations where you might want to consider taking a balance transfer to do it. This is a very risky strategy and should only be done by those who know how balance transfers work.
Where to Open an IRA Account- Affiliate Link
This is not tax advise and I would not advise anybody to do this. Your individual situation is unique and you should consult with a professional tax adviser, not some crazy blogger who brags about being cheap.