Each year, the advent of Spring means longer days, warmer temperatures and new life emerging from the cold of Winter. It also means Tax Day. While the seasons may be predictable, your annual tax obligations and how you plan to pay them can vary year to year.
The tried-and-true solution to a tax bill is to write a check to the IRS. But depending on the size of your bill, the amount of cash you have in reserve, your current investments and market conditions, and your financial goals, there may be years when borrowing to pay the bill makes more sense.
When Is It Advantageous to Borrow for Taxes?
Whether or not borrowing is a smart move during tax season will be unique to each person’s financial situation and goals. Your financial advisors and tax professionals can help you make informed decisions and should always be consulted. But in general, borrowing can make sense in the instance of a tax obligation that is larger than expected or if your liquidity is allocated to a different investment strategy, or your available cash is earmarked for other expenses. It can also be a good solution in the event you would need to liquidate investments to pay a tax bill, which could trigger additional capital gains taxes or other tax obligations. Additionally, disrupting a carefully planned investment strategy could impact potential future market gains.
“Borrowing to pay taxes can be effective, especially when it’s part of a planned strategy to help grow long-term wealth or limit future tax liabilities,” said Jon Kessler, head of Credit and Cash Management for PNC Private Bank. “Considerations impacting the decision include prevailing interest rates, investment timeline and horizon, cash positioning, and one’s overall risk appetite.”
The Power of Your Investments
One of the key benefits of borrowing for a tax bill is that it prevents you from potentially needing to sell assets from your investment portfolio to generate cash. Instead, you can consider borrowing against the value of those investments through a securities-based line of credit (SBLOC). An SBLOC gives you access to a percentage of the value of your investment portfolio and can be used for any purpose other than investing in more securities.
SBLOCs can be attractive solutions because they allow investors to maintain control and benefit from the potential growth of the securities in their portfolio. They’re also quick to put in place, incur no set-up fees, and have interest rates below that of other personal loans. SBLOCs also only require monthly interest payments — meaning the principal can be paid back on your own timeline.
The risk in using an SBLOC is that they are collateralized with the assets in your portfolio. If those assets lose value over time, you may be required to add cash or investments, reallocate parts of the portfolio to generate more borrowing power, or paydown part of the outstanding balance of your credit line to prevent the lender from liquidating some or all of your investments.
Borrowing Against Your Home
Similar to an SBLOC, a home equity line of credit (HELOC) may also be a good source of liquidity to pay a tax bill. A HELOC is a revolving line of credit that allows you to borrow a percentage of the equity you’ve built in your primary home or vacation property. HELOCs often come with rates lower than personal loans or credit cards and – like SBLOCs – have flexible repayment terms, including interest only payment structures.
Choosing What’s Right
“Having access to liquidity without draining your cash reserves or disrupting a carefully planned investment strategy is an important part of achieving your overall financial goals,” said Kessler.
Choosing how or if borrowing to pay a tax bill is right for you will depend on your individual financial situation and goals. Your financial and tax advisors can help determine the right next steps to help you navigate tax season effectively without sacrificing long-term wealth.
