Monday, February 18, 2008

Interest-based Tax Deduction Myth

I am so close to ditching Suze Orman completely and listening solely to Dave Ramsey for financial advice. I have been a Suze Orman fan for about two and a half years or so, but ever since discovering Dave Ramsey on the Fox Business Network in November 2007, I have not enjoyed Suze Orman’s show as much as I did in the past.

On the most recent episode of the Suze Orman Show, a mother called in about her son who just graduated from college with about $85,000 of student loan debt. The lady noted that her son had about $85,000 in stock options and a $120,000 trust from his grandfather. The lady asked if her son should sell the stock and dip into the trust to pay off the loan. Instead of the obvious “yes” that Dave Ramsey would have given, Suze started talking about interest rates and the son’s income. She said given the income and the son’s eligibility for the student loan tax deduction (which means he would save on taxes), he should maybe pay off the student loan that was at 8.25% and make payments on the one that was at 6.125%.

Staying in debt to get a tax deduction is stupid. Let’s do the math.

Suppose I have a student loan whose total interest this year will be $1,000. I have the funds to pay it off completely. But, in order to get the tax deduction, I decide to spend that money elsewhere and make the payments on the student loan.

The upper portion of my income is taxed at 25%. So, if I take that $1,000 off my income, I would save $250 on my tax bill. So, I’ll pay my bank $1,000 in interest in one year so I don’t have to send the IRS $250. Or, I could just pay the debt off in full and pay the $250 in taxes, which will leave me with $750 in my pocket. Even if the deduction put me in the 15% bracket, I would be sending the bank $1,000 so that I would not have to send the government $150.

If you’re paying $10,000 a year in mortgage interest….

So, whether it is a student loan interest or mortgage interest, don’t stretch out loans for the tax deductions, because they don’t make since. If you are that adamant about sending the least amount of money possible to Uncle Sam, give it to a charity.

So, after hearing advice like that from Dave Ramsey, I will be paying my loans off as soon as possible!

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