Living off of margin loans

[Sojourner]

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

While it's an interesting idea in principle, I don't see how it would be worth the effort for me. My passive investment income (dividends and CG distributions) covers about 70% of my spending each year, and the income I generate from selling options covers (roughly) the other 30%. While I could stop selling options, there is no way to stop receiving divs and CGDs without incurring a very large tax hit. And while there could be some tax benefits from replacing my options income with a margin loan, I'm not sure those benefits would be worth the added risk and effort. Besides, I have somewhat of a philosophical issue with paying to borrow money, especially as an ongoing lifestyle choice.

 

[geeky_grrl]

Interesting idea. How does deductibility of margin interest figure in? Are you also continuing investment purchases?

-BB

I haven't really looked into the deductibility much. I know the interest is deductible if you are using a loan to buy securities. I've seen some people claim it is also deductible if you are borrowing to hold a security instead of selling it, but I haven't done the research on the IRS's position. If I go down this path and get enough expenses to itemize I should do that research.

I'm already retired and drawing down so I'm not really continuing investment purchases other than maybe rebalancing at some point.

 

[MikeTN]

Asset-based lending is growing fast. Most financial firms and banks will set up a line of credit. The rates are not usually as low as quoted above. However, it can be very useful if you are making a big ticket purchase or changing houses. Tom Anderson led this program at Merril Lynch and wrote a book, The Value of Debt in Retirement. He asserts that all successful corporations maintain debt, and successful families should too.
Personally, I want to cover my basic expenses with minimal risk; but I have some leverage with the rest of my portfolio. I did this by taking out a mortgage at 2.25% this year and investing the proceeds. However, I learned that getting a mortgage involves a lot more hassle and paperwork than in the past. Asset based lending is popular in part because it is relatively easy to set up a line of credit and use it when you wish.

 

[ERD50]

This could be a very good strategy for some for bridging between retirement and RMD/SS.

If you are in the position where taking RMDs and SS at 70 or 72 will provide more than your expenses, then you can cover any annual shortfalls up until that time with withdrawals from a LOC.

Those withdrawals are not 'income', so that leaves more room for Roth conversions and/or LTCG harvesting.

For example, one could take out a low rate fixed mortgage, make the payments each month by drawing on the LOC (a small amount at first, growing each year) w/o tax implications. Then when RMD/SS hits, the excess above your regular spending (which is taxed anyway) can be applied to the mortgage payment, and paying down the LOC if the rates aren't attractive anymore.

-ERD50

 

[Time2]

This could be a very good strategy for some for bridging between retirement and RMD/SS.

If you are in the position where taking RMDs and SS at 70 or 72 will provide more than your expenses, then you can cover any annual shortfalls up until that time with withdrawals from a LOC.

I suggested this in post #42, it is a little convoluted, but, if you oversaved SS and RMDs will supply more income than you spend, so a great time to payoff the loan (for spending) because, it's income you need to pay tax on that you can't get around.
I'm probably not one to do it, but I'm going to mull it over and massage the numbers. It would allow me to do more in Roth Conversions.

 

[ERD50]

I suggested this in post #42, it is a little convoluted, but, if you oversaved SS and RMDs will supply more income than you spend, so a great time to payoff the loan (for spending) because, it's income you need to pay tax on that you can't get around.
I'm probably not one to do it, but I'm going to mull it over and massage the numbers. It would allow me to do more in Roth Conversions.

Ahhh, that's what got me thinking about it! I guess I just twisted it a little bit with a focus on the 'bridge' aspect, but same thing.

Then I started thinking, why bother with the mortgage, why not just keep the LOC, and pay it off with any excess RMD/SS/pension starting in ~ 4 or 5 years?

And my answer to myself was - because interest rates on that LOC may go way up (I lived through the 80's!), it could take many years to pay down the LOC, and that mortgage is fixed. Good inflation hedge. I'll keep pursueing the mortgage.

And I don't think I'll even need to go the 'asset based' route. I've been doing Roth conversions to the top of the 12%, putting my AGI at ~ $110K, so that should be enough to easily qualify for an 80% LTV mortgage on our home.

-ERD50

 

[geeky_grrl]

And I don't think I'll even need to go the 'asset based' route. I've been doing Roth conversions to the top of the 12%, putting my AGI at ~ $110K, so that should be enough to easily qualify for an 80% LTV mortgage on our home.

-ERD50

Do mortgage lender count Roth conversion as income for a mortgage? I haven't tried to get a mortgage since retiring, but I had heard it was hard to get the lenders to count income from sources like withdrawals from accounts.

 

[ERD50]

Do mortgage lender count Roth conversion as income for a mortgage? I haven't tried to get a mortgage since retiring, but I had heard it was hard to get the lenders to count income from sources like withdrawals from accounts.

We will see. What I gather from others here, is since it is taxable income, and I've been doing it for a few years, I have the 1040 AGI to back it up.

But I have heard others say the withdrawals need to be set up as a regular (monthly?) income stream. Some have said they set it up, and cancelled it as soon as they closed.

It's kind of a game, but rules are rules, the workers processing the loan applications just have to follow the rules, so you just have to play the game.

-ERD50

 

[Time2]

I recently got a HELOC, all I had to do was produce a full statement of my Vanguard account. There were no fees, and I have 90 day 0.99% teaser rate. I have no systematic withdrawals, in fact I usually wait until Dec. to make my withdrawal for next years spending.

 

[clifp]

Do mortgage lender count Roth conversion as income for a mortgage? I haven't tried to get a mortgage since retiring, but I had heard it was hard to get the lenders to count income from sources like withdrawals from accounts.

`Short answer is no, AFAIK.

I was able to qualify for a $750K mortgage, via a combination of assets and setting up an automatic withdrawal from my IRA. My Roth conversion the previous year didn't count for income purposes.

Obviously, this is problematic if you are under 59.5, unless you want to use a Roth withdrawal.

I only did the automatic withdrawal for two months before canceling it. which the broker was fine with.

HELOC is also a possibility although since the interest is no longer deductible (for new HELCO) they are less interesting

I think the first choice is to use the house mortgage because the interest rate is so low, (1.875% for a 15-year) and the interest is deductible.

Then use a margin loan/pledged assets because of he possibility of higher interest rates in the future.

 

[ncbill]

The way I see it is that if you stay at the "magical" 10%, then no matter how the market drops, it is extremely unlikely you will be forced into selling any positions. YMMV.

same for restricting margin to 25%...I see no need to stop at 10%.

 

[walkinwood]

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.

How does this play out in years 2, 3, 4 and so on? That's the part I don't get.

- Do you keep borrowing money with a new margin loan each year?

- Do you ever pay back the loans?

- And where does the money to pay back the loans come from?

 

[geeky_grrl]

How does this play out in years 2, 3, 4 and so on? That's the part I don't get.

- Do you keep borrowing money with a new margin loan each year?

- Do you ever pay back the loans?

- And where does the money to pay back the loans come from?

Each year I would continue to borrow on margin for that years expenses. The interest just accrues and increases the debt. I would never pay the margin loan back, but my estate would have to at my death.

My estate would have a bunch of appreciated stocks/funds and a bunch of debt. Assuming Congress doesn't eliminate stepped-up basis rules, my estate would be able to sell the appreciated assets tax-free and use that to pay the debt.

 

[walkinwood]

Ah. Thanks for the explanation. As long as the loans don't add up to a significant percentage of the portfolio, it works. Otherwise, the danger of a margin call would make it quite risky.

 

[Time2]

In my scenerio, I would pay the loan off when we are collecting SS and have RMDs, in our case, this generates* about 2-1/2 times more income than we spend so we have forced excess income, that we must pay taxes on. We would use that to payoff the margin loan.
Hopefully during those years, we would continue Roth conversions in the 12% bracket to help reduce the RMDs we have to pay.




* all this assumes the stock market continues to grow at 7-10%.
YMMV, as might mine.

 

[corn18]

I was just planning on tax gain harvesting all my LTCG @ 0% from 56-72 and fit in whatever Roth conversions I can at 12%/15%. Seems a lot easier than margin loans until RMD's.

 

[ERD50]

I was just planning on tax gain harvesting all my LTCG @ 0% from 56-72 and fit in whatever Roth conversions I can at 12%/15%. Seems a lot easier than margin loans until RMD's.

Maybe, but with the margin loan you can hold off on those LTCG harvest and max out the Roth conversions.

Assuming the cost basis step up remains in place, those stocks will pass to heirs tax free, assuming you never have to sell them. And that's the scenario Time2 is showing, SS/pension/RM/dividends more than cover expenses, so you may never sell those investments, and the excess is used to pay down the loan

-ERD50

 

[geeky_grrl]

I was just planning on tax gain harvesting all my LTCG @ 0% from 56-72 and fit in whatever Roth conversions I can at 12%/15%. Seems a lot easier than margin loans until RMD's.

Yeah, that is a lot simpler if the harvesting in the 0% bracket is enough for you.
I'm going to go beyond the 0% bracket though - I don't see the need to restrict my spending to that low of a withdrawal rate for my portfolio - so I'm trying to figure out the most effective way to do that.

 

[GTFan]

Could work just fine, but I think the biggest risk is interest rates rising to a point where after a few years your combined debt increases your margin to levels you might not be comfortable with (coupled with a bear market, for example). Much more front and center now given current inflation.

 

[SecondCor521]

I did some rough calculations on another board, and the deductibility of interest, even if it is allowed (I'm dubious), isn't really worth all that much.

Assuming a 3% withdrawal rate, and 2% interest as OP does, the interest is 2% of 3% of $X. OP is single, so the standard deduction is about $12K. Solving $12K = 2% * 3% * $X, the interest only starts becoming deductible in the first year if $X is $20M. if $X is $2M per OP, then it takes about 10 years of doing this before the interest starts to exceed the standard deduction.

Of course, OP might have other itemized deductions that would make it "better", and the compounding of the interest would "help". But by 10 years at 3% withdrawal, that's already 30% of the portfolio withdrawn. Sure, the portfolio is statistically likely to grow during that time, but a market dip at the wrong time could be bad.

@MikeTN, the problem with the thinking in post #53 (not yours, but the guy you mention) is that the downside risk of debt is different between a company and a person or family. If a company runs out of money, it folds up shop and the people walk away. If a person or family runs out of money, they could have trouble buying food and shelter and medical care. The downside risk is greater.

@geeky_grrl, what I would recommend you try to do is model out what would happen in some of the recent worst cases - if you had been doing this for five years or so and then hit a patch like 2000 or 2007/2008 or spring 2020. Would you have had a margin call? How much would you have had to sell at the relative bottom to cover the margin call? What would that do to the safety of your withdrawal rate?

It's easy to say "Oh, I'll just sell some stock" or "Oh, I'll just increase my IRA distributions", just like it's easy for people to say about SORR risk "Oh, I'll just tighten my belt a bit for a year or two". While I don't worry about SORR risk for other reasons, ERN has done the math (probably correctly) to show that the belt tightening has to be much more severe and much more lengthy. My point is that you may be hand waving away a risk that you perceive as small when it actually could be big. If you want to take the risk, sure, but go into it with the analysis done so your assessment of the risk is informed and realistic rather than vague.

 

[2177V]

Have you attempted to do a margin loan for living expenses without using the proceeds to reinvest? Some financial institutions may have some restrictions.

 

[Koolau]

Even if I could justify the approach, I'd never do it as I would worry about the downside. Sleep is more important at my advanced age than maximizing my spending or investment results. YMMV

 

[Bongleur]

What happens if you do this for 10 years and then have to pay off the loan, but the Cap Gains tax rate has doubled ?

Is it really correct that when you die, your estate can sell stock to pay off your debt WITHOUT paying cap gains taxes? AFAIK it is your heirs that get the step-up in basis, so its only on the remainder of your estate after taxes which they inherit.

 

[SecondCor521]

Is it really correct that when you die, your estate can sell stock to pay off your debt WITHOUT paying cap gains taxes? AFAIK it is your heirs that get the step-up in basis, so its only on the remainder of your estate after taxes which they inherit.

Yes.

The basis step up applies to estate assets. From the instructions for Form 1041 Schedule D:

"Basis of decedent's estate property. Generally, the basis of property acquired by a decedent's estate is the FMV of the property at the date of the decedent's death, or the alternate valuation date if the executor elected to use an alternate valuation under section 2032."

-- https://www.irs.gov/instructions/i1041sd#idm140693667804656

Of course, the estate return might still reflect a capital gain (if, for example, the estate held a stock that had gone up in value between the date of death and the date of sale). The estate would then owe capital gains taxes, or it could choose to distribute the capital gain to the beneficiaries of the estate on a K-1. But in general these capital gains taxes would be relatively small due to the step up in basis.

 

[thepalmersinking]

DO NOT DO IT! My partner did that and died penniless on a $5mil portfolio. ML convinced him to do it. In a downturn you get slaughtered. He took a $250K loan out every January and paid it back by selling the ‘gains’ and repeating each year. Imagine losing 40% of your portfolio and then selling stock to pay off a loan. Poof in 3years he was basically broke.