Three planning questions you may be asking now

What are the advantages of tax-aware borrowing?

Tax-aware borrowing involves structuring a debt to optimize its deductibility as a way to potentially lower federal and state tax obligations, improve cash flow and, in the process, effectively reduce related borrowing costs.

However, it’s important to keep in mind: U.S. tax laws do not treat all interest expenses in the same way.

1. Qualified residence interest—Interest deductions for qualified residential home mortgages are currently capped at $750,000 of principal indebtedness ($375,000 if married filing separately). Thus, for those buying a more expensive home, the mortgage interest may not be fully deductible.
2. Investment interest expense—Borrowing for investment purposes is often better, tax-wise, than borrowing to purchase a home. Taxpayers are allowed to deduct investment interest expense up to the total amount of their investment income for that year.¹ Moreover, unlike with mortgages, there is no cap on the amount of principal indebtedness against which this deduction may be taken, provided the individual has enough investment income (from all sources) to use it against.         
   
   One further benefit: If the investment interest paid in a given year is more than your investment income, any excess deduction can be carried forward indefinitely.
   For these purposes, investment income generally includes:
   
   • Interest (such as from corporate bonds)
   • Dividends that do not qualify for the preferential 20% top tax rate
   • Annuities and royalties
   • Preferentially taxed qualified dividends and long-term capital gains (to the extent the taxpayer elects to have them taxed at ordinary income rates)
   • Possibly income from private equity investments and hedge funds
     
     Rental income, however, generally is not considered investment income.
3. Trade or business expense—Interest expense on loans taken for capital commitments to an operating trade or business in pass-through form (e.g., sole proprietorship, S corporation or partnership) is deductible against business income in determining net profit or loss. If the business has a net loss, the ability to deduct that loss against other types of income depends on the taxpayer’s relationship to the business^.2

One example of tax-aware borrowing is taking a mortgage on an unencumbered home and using the proceeds for taxable investments. This allows the borrower to gain liquidity from a tangible asset that is then deployed for investment opportunities. Generally, borrowing in such a way as to have the interest due be considered an “investment interest expense” would be optimal. As good as the mortgage interest deduction might be, the interest may not be fully deductible for those who are buying a more expensive home, since the deduction is currently capped at $750,000 of principal indebtedness ($375,000 if married filing separately).

For these individuals, borrowing for investment purposes is often better, tax-wise, than borrowing to purchase a home. The reason: You can deduct investment interest expense up to the total amount of your investment income for that year. 

How can I protect my retirement plans?

During periods of volatility, recent retirees are often the most vulnerable because of sequence of return risk. Big market downturns either just before or shortly after an individual retires generally are more difficult to recover from, especially if depressed assets are being used to fund lifestyle expenses. The potential impact of a sharp downturn on retirement assets is illustrated in the following chart.

While volatility may threaten your plans, taking one or more of these steps can help you stay the course:

1. Determine your risk capacity: Assess how much market volatility your portfolio can endure without jeopardizing your financial plans by stress testing against spending goals, inflation and adverse market conditions.
2. Lean on cash for spending: Maintain a liquidity reserve to cover two to five years of expenses, and use this cash for spending instead of selling investments.
3. Use leverage to your advantage: Borrow against assets, such as permanent life insurance policies with cash value, to avoid portfolio withdrawals during market downturns.
4. Implement a dynamic withdrawal strategy: Enhance your plan’s resilience by adjusting withdrawal amounts during periods of market volatility to mitigate sequence of return risk.

Learn more about how we can help your navigate volatility and protect your retirement plans here.

We Can Help

Your Private Bank team, working closely with specialists in J.P. Morgan’s Private Advisory practice and your tax advisors, can help you make strategic planning and investment decisions using our proprietary Wealth Plan Plus technology. As a starting point, your team can analyze your entire balance sheet to evaluate how well you are currently positioned to reach your longer-term goals. To learn more about how we tailor planning strategies to your personal situation, speak with your J.P. Morgan team. 

¹The likelihood of interest deductibility is largely dependent on an investor’s particular circumstances. Borrowing to purchase or carry tax-exempt obligations can limit the deductibility of investment interest expense. Deductibility may also be limited or deferred, for example, if the individual does not have sufficient “net investment income,” or the investor holds market discount bond. A tax bill passed by the House of Representatives on May 22 and under consideration in the Senate would, if enacted as is, cap the value of each dollar of itemized deductions at 35%, in most cases, for taxpayers in the top (37%) income tax bracket, starting January 1, 2026.

²Interest deductible as a trade or business expense is generally an “above-the-line,” dollar-for-dollar offset against business income; however, if the business generates a net loss, the ability to take that loss against other income depends on whether the taxpayer is a “material participant” or a passive investor in the business.