With only one day left until Tax Day, some wealthy Americans are paying Uncle Sam using well-established wealth-building strategies. It’s a bank loan.
Wealth management clients with large stock and bond portfolios have long used their holdings as collateral for loans to finance their dreams, from buying a beach villa to acquiring a 1963 Ferrari GTO. . “just because,” as Morgan Stanley once said.
but,”Buy, borrow and die strategyA term coined nearly 30 years ago by Edward McCaffery, an economist at the University of Southern California, to describe how wealthy individuals avoid capital gains taxes on their investment profits, the amount of money owed to the Internal Revenue Service. is also used to pay for
Borrowing money to pay taxes is “unusual, but it’s a really good strategy,” said Kenneth Van Leeuwen, managing director of property management firm Van Leeuwen & Co. in Princeton, New Jersey. .
Large banks and brokerage firms are actively trading by selling what are known as securities-based loans to their wealthiest customers. At lower interest rates than personal loans and home equity lines of credit, borrowers can use the security as collateral for cash without having to sell their investment.
The idea is that borrowing is worthwhile if you believe the return on the secured investment will exceed the interest you pay. Investors can typically borrow at least 50% of the value of their portfolio.
wells fargofor example, the bank charges prime rate to clients under management of less than $2.5 million — 8% as of last Friday. Customer pays 6.45% by bank.
In a Feb. 23 memo, Morgan Stanley said, “The application process for these loans tends to be quick, taking only a few days, and requires relatively few documents. short deadline for tax payment.”
in contrast, Personal Loan Start Date According to Bankrate, the average home equity loan is 8%, but those with the best credit are 10.7% to 12.5% higher.
Securities-based loans are often used to pay for extravagant weddings and expensive college tuition, but wealth advisors tell us how clients deal with unexpected or one-off tax expenses. is not fully utilized. One such situation concerns stock grants known as restricted stock units.
That equity is usually granted to middle and senior management by employers as part of their overall remuneration. Once vested, it becomes taxable and meaning becomes available to employees after hurdles related to performance goals and tenure with the company are met. The vesting date triggers a tax charge even if the officer does not sell the shares.
Since shares are similar to salary-like income, they are taxed at the normal rate, currently in the top 37%. Let’s take someone in that top bracket. In their company he had 50,000 RSUs, worth $20 each when granted. Once vested after 2 years, it’s worth $30 per person. That means he would be subject to $18,500 in federal taxes on a $50,000 valuation.
pay taxes in style
A security-based loan, also known as a security-based line of credit (SBLOC), has a lot in common with its better-known cousin, a margin loan. Both involve an investor borrowing money against a security and both have variable interest rates.
However, unlike margin loans, security-based loans Cannot be used to purchase or trade securitiesInterest payments on either loan are deductible only if the earnings were used to generate taxable income, such as remodeling a home, investing in a startup, or buying additional stock. A security-based loan cannot be used to purchase stock, and interest is not deductible if used to pay taxes.
Loans are generally only available to high net worth and ultra high net worth clients. in contrast, Margin loans are usually required According to Charles Schwab, the minimum minimum amount of cash or “marginable” securities is $2,000 and is usually capped at 50% of the portfolio value.
“We tend to recommend actually setting up an SBLOC at the time of account opening, so you don’t have to rush to get that line of credit in an emergency,” said Andy Watts, vice president. says. He develops planning and wealth solutions at Avantax Wealth Management, a tax-focused wealth management firm in Dallas. “It’s a great way to postpone any kind of tax event if you have to pay taxes.”
Van Leeuwen, an executive at TJ Maxx, last year used a $200,000 portfolio of stocks and bonds to obtain a margin loan from Goldman Sachs at an interest rate of about 6% and invested in TJ Maxx’s restricted equity unit. I mentioned paying $10,000 in taxes owed. had given. Van Leeuwen said the client was not considered large enough for securities-based loans at slightly lower interest rates.
Of course, many wealth advisors prefer their clients to use their savings to pay taxes.
“If you have cash, use cash to pay your bills,” says van Leeuwen.
However, it is not always an option when large buckets of restricted stock units vest.
“If you can borrow at a lower rate and think the stock price will go up, it’s worth paying 6%,” Van Leeuwen said.
Growth Opportunities for Independent Advisors
All major banks, brokerage firms and brokerage firms offer securities-based loans, but independent advisors have been slow to embrace the trend.
Broadridge, a financial technology company in Lake Success, New York, said in its 2023 report: 5% of wealth management accounts is used as collateral for security-based loans, the interest rate of which will double every three years, the company said. The company expects a generally defined high net worth investor with liquid assets ranging from $100,000 to he $1 million to account for his 41% of total securities-based loans within three years. I predict it will be
According to Broadridge, loans are “an effective tool that helps advisors broaden the conversation with their clients. No news here, but access to credit faces challenges with the companies that provide it.” It is an absolute table stake for companies that are not: a real threat to their ability to effectively expand their wealth offering.”
Neither the financial industry regulator, which oversees brokers, nor Wall Street’s regulator, the Securities and Exchange Commission, track the volume of securities-based loans.His 2017 op-ed by Zohar Swaine, founder and president of Mink Hollow Advisors, a New York strategy consulting firm for the wealth management industry make the industry $200 billionwell below nearly Margin loan balance of $643 billion FINRA tracked at the end of 2017.
more risk
When the Federal Reserve begins raising rates in March 2021, interest rates for both margin and securities-based loans will About 6% of 3 timesmargin loan balances plummeted from a third to just over $600 billion, according to data cited by AllianceBernstein. The asset manager predicted that a combination of three factors would make his traditional 60/40 portfolio’s long-term return likely to be 5.6%, with current margins lower than his loan rates. Higher interest rates; market volatility that can force margin calls – combine to create a strategy of borrowing against securities.”Dangerous — and incredibly costly.”
In other words, last year’s terrible stock and bond markets made it more risky for investors to promise the value of their securities for the money they borrowed. yeah.
For example, Bank of America reported US securities-based lending loans $50.4 billion at the end of last yearmarginally down from $51.1 billion at the end of 2021, and $41.1 billion in 2020before interest rates soared.
“A lot of investors are now holding stocks that they think are undervalued, which is why this is such a great strategy,” Van Leeuwen said. He added that he didn’t want to sell stocks that he thought would go up.
But he said the approach was “difficult” for investors. Because if the market crashes and the securities backing the loans fall in value, the banks can demand immediate repayment. “There is an element of risk there.”