Living off of margin loans

[geeky_grrl]

With the stories in the news about how the ultra rich live off of their assets by borrowing against them instead of selling and realizing capital gains, I started wondering if the strategy was possible with a smaller portfolio. Would it be advantageous for taxes to just live off of margin loans?

For example, say I had $2,000,000 invested at my brokerage and I can borrow at 2% interest and I want to pull $60,000 out each year. I get a margin loan for the $60k and over the year it accrues around $1,200 in interest. Even assuming a pretty low rate of return like 4% it seems to work out pretty well

Overly simplified numbers (assuming everything is withdrawal at the beginning of the year for easier math).
Margin loan:
$2,000,000 initial portfolio * 1.04 = $2,080,000
- 61,200 loan balance = $2,018,800 net worth

Withdrawals (I'm assuming 5% tax on my withdrawals for LTCG):
$2,000,0000 - $63,000 = 1,937,000 * 1.04 = $2,014,480

I'd probably also be able to get a better ACA subsidy which I didn't factor in.

The main risk I see is if we have a period where interest rates exceed stock market returns. This strategy would not have worked well in the 70s/early 80s when interest rates were sky-high. I figure if rates started going up a lot I could take the hit and liquidate some stocks or dip into my Roth accounts to decrease my margin balance.

Margin loans and the risk of margin calls scare me somewhat, but the risk of a margin at with that small of my portfolio seems pretty low. I'd probably be looking at this strategy as a bridge until social security and RMDs kick in. I think I could probably keep my margin loan to under 25% of my taxable brokerage assets which seems pretty low risk to me.

What am I missing? It seems like a better strategy to do the margin loans vs. withdrawals, but I'm assuming that if it was clearly better more people would be talking about it.

 

[JDARNELL]

Can you get a Margin loan at that rate? I am seeing 6% to 8%

 

[geeky_grrl]

Interactive Brokers is 1.58% for < $100k and the rates go down for larger loans.

 

[JDARNELL]

Seems if you keep your leverage percentage low then you will run very low risk of a margin call. I had a short term cash need this month that I didn't want to create a taxable event in my account as it was gonna drive some what I view as draconian tax penalties so I checked into a Margin loan and a personal loan from Penfed to control this years income level. I went with the personal loan which will be eliminated in the next 90 days.

I think what you are talking about is doable.

 

[street]

I have nothing to add or any experience doing it but I know that the method is used. I have read/heard about people using this way to live and make money doing it. I can't imagine it not working but would be nice to have a finance person take care of the process.

 

[Retireby45ish]

What a great idea. Looking forward to hearing what people have to say on this.

The only thing I can think of is that you would need to sell the assets to pay the margin loan back eventually and that would put you into a higher tax bracket at that point. I guess if you picked points as you were nearing next tax bracket from one year to the next it might work.

 

[tb001]

Yes. We looked into it and have thought about this as a longer term strategy. But it requires moving a significant of our portfolio to interactive brokers, which we’re not ready to do yet. I think some folks at bogleheads have said they were able to negotiate more competitive rates at other brokers as well.

It’s still a possibility for us, but the interest rate variability makes me nervous. We’ve also looked into refinancing and taking out a longer term mortgage.

I’ll be curious to hear others chime in. At historically low interest rates it seems easy, but I remember the 80s…

 

[tb001]

Just to add, there are also some transfer of wealth on death perks which can be substantial for the wealthy.

The other potential catch is the bank can pretty much call the loan whenever they want. While as far as I know they don’t do it, the fine print on the terms was pretty loose in terms of what they could do.

 

[Markola]

The ultra rich might do it but sometimes it blows up on them, like anyone. Before the dot com bust, the grand dame of the founding family one of our state’s largest S&P 500 corporations borrowed against her holdings of another of the state’s high-flying tech stocks. She wanted money to fix up the family mansion. At the time, that tech stock had the highest market cap in the state. Sad story short, the stock fell from $52 to $2 in the bust, and the mansion went up for sale.

 

[geeky_grrl]

The ultra rich might do it but sometimes it blows up on them, like anyone. Before the dot com bust, the grand dame of the founding family one of our state’s largest S&P 500 corporations borrowed against her holdings of another of the state’s high-flying tech stocks. She wanted money to fix up the family mansion. At the time, that tech stock had the highest market cap in the state. Sad story short, the stock fell from $52 to $2 in the bust, and the mansion went up for sale.

Yeah, obviously there is the risk of assets depreciating and having a margin call. My portfolio is mostly in broad based index funds. If they drop 95% of their value I'll be pretty screwed no matter what my strategy is. I figured my risk tolerance is probably borrowing up to 25% of their value.

 

[Luvtoride]

This sounds to me like a reverse mortgage but instead of using your house as collateral you’re using your portfolio as collateral.
I’m surprised that ideas like this are considered here given the popularity on this forum of being debt free and paying off low rate mortgages early.
To each their own.

 

[38Chevy454]

Maybe I'm missing the simple math, but why pay 2% cost for money when you are making sufficient off your assets to cover your budget needs and having lower net costs for the money. You still need to pay back the borrowed money. I don't see the savings. It only seems a plan to delay the taxes.

 

[geeky_grrl]

Maybe I'm missing the simple math, but why pay 2% cost for money when you are making sufficient off your assets to cover your budget needs and having lower net costs for the money. You still need to pay back the borrowed money. I don't see the savings. It only seems a plan to delay the taxes.

First, I think my money in the market will get more than 2% return, so it is a net advantage to keep the money invested rather than selling shares to live off of. It really the same argument about why it is better to keep a mortgage or have a car loan when the interest rates are low.

Second, it avoids the taxes for my lifetime. I'll never have to sell the shares and realize capital gains as long over time the stocks appreciate more than I'm paying in interest. That saves me a few thousand dollars a year in capital gains. If the current tax laws about stepped up basis at death stays the same my heirs won't have to pay capital gains either. But I don't care as much about the taxes once I am gone anyhow.

 

[FIRE'd@51]

Actually, a couple filing a joint return would pay no Federal taxes on taxable income up to 79K (the top of the 12% bracket) if all that income came from LT capital gains (and qualified dividends). Add the 24K standard deduction and their gross income could actually be 103K and they would still pay no Federal taxes.

 

[NW-Bound]

Actually, a couple filing a joint return would pay no Federal taxes on taxable income up to 79K (the top of the 12% bracket) if all that income came from LT capital gains (and qualified dividends). Add the 24K standard deduction and their gross income could actually be 103K and they would still pay no Federal taxes.

+1

The OP was talking about getting $60K each year. Not all of that $60K has to be capital gain either.

In fact, I would sell some appreciated stocks and immediately buy them back to wash off the cap gain, in order to make use of the tax-free bracket each year.

I was able to do the above for a few years immediately after ER, and paid nearly no taxes. But then, I eventually drew down my after-tax accounts for living expenses, while waiting till 59-1/2 to be able to tap my 401+IRA.

I wish I had more money in the after-tax account, in order to take advantage of the $103k tax-free investment income. But as it is now, I pay regular income taxes on all my withdrawals.

 

[geeky_grrl]

Actually, a couple filing a joint return would pay no Federal taxes on taxable income up to 79K (the top of the 12% bracket) if all that income came from capital gains (and qualified dividends). Add the 24K standard deduction and their gross income could actually be 103K and they would still pay no Federal taxes.

I can see how my strategy isn't useful if you don't pay cap gains. But I'm single so I only have $52k of cap gains before I pay taxes. I have quite a bit of qualified dividends so I end up paying cap gains on a lot of my stock. And my state taxes are pretty high and they don't have any preferential treatment for cap gains or qualified dividends.

I did a mock return for last year taking my cap gains out and would have saved me almost $6k last year on sales of $69k of stock, so even after interest I'd still be up over $4k if I borrowed instead of selling.

 

[ERD50]

This sounds to me like a reverse mortgage but instead of using your house as collateral you’re using your portfolio as collateral.
I’m surprised that ideas like this are considered here given the popularity on this forum of being debt free and paying off low rate mortgages early.
To each their own.

Don't over-generalize. Yes, a lot of posters see being debt free and paying off a mortgage as a big deal, but there are also many of us who are very happy seeing our money work for us, and maintain low rate mortgages, and any low rate debt we can find (0% car loan with no 'gotchas', etc).

-ERD50

 

[Scuba]

I can see how my strategy isn't useful if you don't pay cap gains. But I'm single so I only have $52k of cap gains before I pay taxes. I have quite a bit of qualified dividends so I end up paying cap gains on a lot of my stock. And my state taxes are pretty high and they don't have any preferential treatment for cap gains or qualified dividends.



I did a mock return for last year taking my cap gains out and would have saved me almost $6k last year on sales of $69k of stock, so even after interest I'd still be up over $4k if I borrowed instead of selling.

Interesting idea. Thanks for sharing.

 

[Closet_Gamer]

Interesting idea though the bear market/crash, margin-call risk would scare me right out of this strategy.

I suppose you could wire some type of put position into place to hedge that risk, but the cost of doing that would probably eat up all the benefits of the strategy.

 

[corn18]

Should work well until it doesn't. This strategy works while the 10yr rate is being held down by the Fed. Once they have the guts to let the market determine the rates, IB won't be offering 2% margin loans anymore. And a mortgage will be be @ 9%.

The folks that were doing this in 2007 probably thought it was a good idea, too. $2M isn't rich. $200M is.

 

[MarieIG]

While there may be benefits in margin borrowing for some, there is simply too much risk for me.

 

[jazz4cash]

This sounds to me like a reverse mortgage but instead of using your house as collateral you’re using your portfolio as collateral.
I’m surprised that ideas like this are considered here given the popularity on this forum of being debt free and paying off low rate mortgages early.
To each their own.

I see why that might come to mind but I don’t think there is any equivalent to a margin call for a reverse mortgage. If housing prices collapse the lender is on the short end not the borrower plus I think insurance is required for the loan.

 

[jazz4cash]

Don't over-generalize. Yes, a lot of posters see being debt free and paying off a mortgage as a big deal, but there are also many of us who are very happy seeing our money work for us, and maintain low rate mortgages, and any low rate debt we can find (0% car loan with no 'gotchas', etc).

-ERD50

That’s what I was thinking also.

 

[Sunset]

I think it can be a great idea, however I'm imaging doing this for 10 years, all is fine assuming interest rates don't jump.
At this point I would owe $600,000 , now SS starts and RMD's start. So maybe I don't need to borrow anymore ?

Yet I have the debt and am paying probably a lot more than 2% ($12,000) maybe it's $24,000 per year, forever.

I am a bit trapped now, as I'd need to sell quite a lot of stock , $100K worth per year to slowly pay off the debt, but this will push up my tax rate quite a bit.

Currently I turn off re-investment of dividends so that I get the cash available tax free as a source of income.

I suppose if I had a TON of money, and didn't have the related lifestyle, I could do this and never pay off the debt then upon death, pay off the debt (with huge tax result). A possible trick would be my heirs get the stepped up basis, sell stock tax free, pay off my debt and then inherit the stocks held as collateral to the debt. (not sure if this is legal, or possible, but certainly tempting with co-operative heirs).

 

[geeky_grrl]

I suppose if I had a TON of money, and didn't have the related lifestyle, I could do this and never pay off the debt then upon death, pay off the debt (with huge tax result). A possible trick would be my heirs get the stepped up basis, sell stock tax free, pay off my debt and then inherit the stocks held as collateral to the debt. (not sure if this is legal, or possible, but certainly tempting with co-operative heirs).

The strategy in general is to never pay off the debt - as long as the underlying assets grow faster than the debt your net worth continues to grow. I found some articles referring to this as strategy "Buy, borrow, die". The estate gets the stepped up basis so when they liquidate assets to pay the debt to settle the estate there is basically no capital gains tax. I don't think you need cooperating heirs - the executor should have the power to sell assets to settle the estates debt. It is possible tax laws change in the future so there is that risk.