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As the end of the 2012 tax year approaches, it dawned on me that with little goodies like the home mortgage interest deduction and property tax deductions, other forms of saving and investment essentially punish the middle class.
Suppose a household earning $100,000 a year purchases a home for $250,000. For a 30-year mortgage at an interest rate of 3 percent, monthly payments (not including escrow payments) would be $1,054 a month. The total interest payments for the first 5 years would be as follows
The interest payments fall each year as more money is paid toward principle. But initially for this household, assuming a 25 percent tax bracket, the interest deduction reduces their tax liability substantially. Moreover, most homebuyers look at their homes as investments, not just a place car insurance quotes to live. Thus, building up equity that can be drawn on later is an important selling point used to entice homebuyers. But as we have learned recently, homes don’t always produce a positive rate of return in the short or long run, particularly when factoring in the cost of insurance and maintenance.
Suppose the household was to limit their mortgage expense (say, purchase a $150,000 home over a 15 year mortgage at 2.5 percent), taken the extra money that would have gone into interest payment for the $250,000 home described above, and instead invest it ino a non-retirement account mutual fund. Their tax advantage would fall significantly, as seen below:
Note that these are back-of-the-envelope calculations and do not include the additional housing subsidy provided by the property tax deduction for homes, and the additional tax imposed on accrued dividends from a mutual fund.
The only way that this household can reap any benefits from non-house investing is by contributing to an IRA or 401(k) account. But even these can pose problems. For one thing, homes provide immediate gratification, while retirement accounts do not since they are intended
for – well – retirement. Also, for households without access to a company-sponsored 401(k) account, the only other option is an IRA account with a 2013 contribution limit of $5,500. This means their maximum reduction in tax liability is only $1,375. Thus it is no wonder that middle-income earners are not shuffling more money into mutual funds, stocks, bonds or other savings and investments. The tax code truly discourages it and there is little incentive for the average earner to prepare for the future.
No good saving goes unpunished. Besides saving us from the upcoming fiscal cliff, it”s time for Congress to change the tax code so it does not favor one investment over another.