Do Wealthy People Take Out Loans to Lower Taxes

[Koolau]

3 x 7 = 21. And 21 is greater than 20. So 3 years of 7% is about 'breakeven'. I don't think the math is much more complicated than that.

But there are some complications - the 20% tax is on the gains only, so it would depend on how appreciated the asset was. If the investment was doubled from purchase, the tax would then be 10% of what they sold, etc.

And, if they can make 7% on the invested money, it's a wash. So it all depends.

So it all depends on your total increase in taxes PLUS stuff like IRMAA and NIIT and/or other. I could see upwards of 40% total which would perhaps give you more like 6 x 7 = 42. So, it's all in the details and YMMV.

 

[Enuff2Eat]

3 x 7 = 21. And 21 is greater than 20. So 3 years of 7% is about 'breakeven'. I don't think the math is much more complicated than that.

But there are some complications - the 20% tax is on the gains only, so it would depend on how appreciated the asset was. If the investment was doubled from purchase, the tax would then be 10% of what they sold, etc.

And, if they can make 7% on the invested money, it's a wash. So it all depends.

thank you Mr. ERD50. Something for me to think about. Unless the interest is tax deductable or else, I am not so sure.

 

[Winemaker]

can someone do a mathematic chart comparasion.. between 7% in a long term vs. 20% income tax once?

Don't look at it as a one time event; some do this every year for a period of years.

 

[ERD50]

^ I guess it might be good to distinguish between this idea being used as a key wealth building idea vs. a way to save a few bucks on taxes.

Several people on this board have mentioned executing the latter idea - postponing realization of income on five figures over a year or three. This approach makes sense to me although I've never done it personally (yet).

The former idea - borrowing all of one's living expenses for years on end - is somewhat different I think because it can be an order of magnitude or more larger.

But isn't that what several of us have done with a 30 year fixed mortgage? By not pulling out several hundred thousand to pay cash/pay-off the home, and pay cap gains (losing more growth opportunity), those investments will very likely grow over 20-30 years and go to heirs at the step up.

My investments don't kick off enough divs to pay my living expenses, let alone the mortgage payment. So it's not a cash flow thing, it's an investment growth and tax thing (for me).

 

[SecondCor521]

But isn't that what several of us have done with a 30 year fixed mortgage? By not pulling out several hundred thousand to pay cash/pay-off the home, and pay cap gains (losing more growth opportunity), those investments will very likely grow over 20-30 years and go to heirs at the step up.

My investments don't kick off enough divs to pay my living expenses, let alone the mortgage payment. So it's not a cash flow thing, it's an investment growth and tax thing (for me).

Yes, more or less.

There are a couple of differences I see. First, when I took out my mortgage, one main reason I did so is that I did not have the cash or investments on hand to buy the house outright. Second, I paid off my house fairly aggressively - I started with a 30 year mortgage, refinanced to get a lower rate twice, and paid it off in about 8 years. Third, after paying off my mortgage I kept it paid off. All in all, I was minimizing the leverage, not maximizing it.

I think @Nords was a serial refinancer whose approach is more similar to the idea in this thread. It has probably worked out well for him. There might be others who have done likewise. I would have been better off had I kept my 2% 15 year mortgage longer, but I preferred the simplicity, lower cash flow needs, and FAFSA benefits to having it paid off when I did.

 

[Winemaker]

It's a modified reverse mortgage type strategy.

 

[Nords]

I think @Nords was a serial refinancer whose approach is more similar to the idea in this thread. It has probably worked out well for him. There might be others who have done likewise.

Why yes, yes we are doing that. The spreadsheet has just reached its 20th anniversary.

For those who've joined here after 2014 (or for those older longer-term members who'd enjoy a stroll down memory lane), here's the original 2004 thread:

Covering a mortgage without losing your ass(ets).

Let's put some numbers to the eternal reciprocated diatribes on rent vs own & mortgage vs debt free. I'm not claiming that ownership is always better than renting, or that mortgages are always better than debt-free. Those are personal choices and they probably should have a bigger emotional...

www.early-retirement.org

Instead of a margin loan on a brokerage account, we're essentially borrowing against my future (inflation-adjusted) military pension deposits (using our home as the collateral) and investing the mortgage money.

The tactic works best when the vast majority of your asset allocation is earning more (after taxes) than the interest rate of your mortgage. It doesn't make much sense to borrow at a mortgage rate that's higher than the yields of bonds or even cash. In our case (again, because of my military pension) we've invested in >90% equities for over two decades.

As "serial refinancers" we refi'd the mortgage six times between 2004-2017 for 30-year fixed interest rates from 5.50% to 3.50%. Each refi restarted the 30-year clock and paid for itself in a year or two.

Back when we started this tactic (October 2004) we compared our mortgage interest rate to a small-cap value index ETF (IJS), reinvesting the small dividends (after paying taxes). It was very volatile, and the long-term compounded annual growth rate actually dipped negative for a few months in 2008-09. Even then, though, we were making fixed principal & interest payments on a loan while my military pension rose at the same cost-of-living adjustment as Social Security.

The CAGR during 2004-2017 was 9.04%. That's a sequence of returns risk, but since it included the Great Recession I think it's a reasonable demonstration of both long-term returns and volatility.

In 2017 we cut our investment expense ratios even further by moving out of IJS (in a tax-efficient manner) to the Vanguard total stock market index ETF (VTI).

The CAGR (as of October 2024) has been 13.28%. Of course this is unsustainable, but as it slowly reverts to the mean of the long-term return of the U.S. total stock market it'll still be a lot higher than 3.50%.

We'll pay off this mortgage in September 2047, just before we celebrate my 87th birthday.

Jim Dahle, the White Coat Investor, has written a blog post suggesting that this leverage is only worth doing if it's roughly 15%-35% of your net worth. Any higher, and the risk might wipe you out to the point of returning to the workforce. Any lower, and it's tinkering at the margins of your wealth.

 

[SecondCor521]

Jim Dahle, the White Coat Investor, has written a blog post suggesting that this leverage is only worth doing if it's roughly 15%-35% of your net worth. Any higher, and the risk might wipe you out to the point of returning to the workforce. Any lower, and it's tinkering at the margins of your wealth.

I like this point. My house is only about 7% of my net worth, so it feels like tinkering. I can see how it makes sense for you though.

 

[yakers]

Not much use thinking about the super rich IMHO, only knew one family (multi$B) and you d have to go back to school to manage finances. Nothing like even the working very wealthy. They buy everything, all over the place, all the time. They don't buy insurance they buy insurance companies. Oh, they may have Lloyds make up special issues for them. VERY inheritance oriented.

 

[SMiller]

100% True. If you're into podcasts, listen to this one. It's the Oct 8 episode.

Search Engine | Search Engine Podcast

Search Engine is the podcast that answers the questions that keep you up at night.

www.searchengine.show

 

[Anchors Aweigh1]

I'm not expert on this but I believe the idea is that instead of paying taxes on highly gained stocks, the rich can take out loans at very good rates based on their stock holdings at excellent interest rates, way less than paying taxes. Rinse and repeat until they die, and the stocks are inherited at stepped up basis. No taxes incurred except for inheritance taxes. I don't know if this is a better way than selling as needed, but I doubt I'll need to worry about this.

This is correct have to die to execute the final part of this strategy so you need high net worth

 

[davidfin]

Our neighbor, a young financial advisor, told my DH the rich take out loans to avoid paying taxes. They take out loans against stock index funds. Then pay back the loans via selling the stock. Because it's a loan, you don't have to pay taxes it. Has anyone heard of this strategy? You pay interest on the loan which is less than the tax you'd pay selling the stock. Maybe this strategy is for the ultra rich who can weather a market downturn. Our neighbor, bless his heart, is always coming up with these unusual financial gimmicks. We won't give him a dime to play with, but find his financial ideas entertaining.

I think many may tap their HELOC for bridging the end of the year to avoid IRMAA for example when expenses are lumpy. Helps avoid a year long tax for a relatively small interest expense.

 

[indiajust]

https://archive.is/ILles

this is a non paywalled site.

Another practice I came across is C-suite selling of stock options to ESOPs and for employee awards. Use goldman or JPM to write a collar around your options, take the cash while selling off the up and downside. Meanwhile sell your option grants to fulfill corporate needs at full value, while receiving top up additional grants so your total never goes down. The cash from the collar is your ongoing payment. The cash from selling for corporate transfers is hidden by the top up.

 

[Palafo]

Our neighbor, a young financial advisor, told my DH the rich take out loans to avoid paying taxes. They take out loans against stock index funds. Then pay back the loans via selling the stock. Because it's a loan, you don't have to pay taxes it. Has anyone heard of this strategy? You pay interest on the loan which is less than the tax you'd pay selling the stock. Maybe this strategy is for the ultra rich who can weather a market downturn. Our neighbor, bless his heart, is always coming up with these unusual financial gimmicks. We won't give him a dime to play with, but find his financial ideas entertaining.

Yes, this is a tactic of the super-rich. They get special low rates. Instead of realizing gains, they just take out loans. Sometimes they don't even bother paying them back until they die. Propublica had a big expose, and this is why some want to tax unrealized gains of billionaires. Jeff Bezos of Amazon showed so little earned income that he qualified for the low-income child-care tax credit.

Some reading:

The Secret IRS Files: Trove of Never-Before-Seen Records Reveal How the Wealthiest Avoid Income Tax

ProPublica has obtained a vast cache of IRS information showing how billionaires like Jeff Bezos, Elon Musk and Warren Buffett pay little in income tax compared to their massive wealth — sometimes, even nothing.

www.propublica.org

Ten Ways Billionaires Avoid Taxes on an Epic Scale

After a year of reporting on the tax machinations of the ultrawealthy, ProPublica spotlights the top tax-avoidance techniques that provide massive benefits to billionaires.

www.propublica.org

These Real Estate and Oil Tycoons Avoided Paying Taxes for Years

Donald Trump and other ultrarich Americans have earned billions, but they’ve also managed to repeatedly avoid paying any federal income tax by claiming huge losses on their businesses.

www.propublica.org

Podcast: Search Engine | Why is it so hard to tax billionaires? (Part 1)

and part 2 Search Engine - Podcast | Global Player

Lesser mortals can probably bridge themselves with margin loans and HELOCs but they will pay a lot more in interest

 

[hotwired]

6% annually for 20 years is a lot more than 20% once.

Plus they won't be paying those rates, they'll be paying 0, 10, 15 or 20 LTCG rates

 

[Perryinva]

The OP specifically said they avoid taxes when “they sell the stocks to pay off the loan”. This is completely different than most of the examples given here where you are showing it makes sense to take out a loan rather than sell stock and pay taxes to fund something. Heck, that’s pretty much the main reason many have low interest rate mortgages in retirement when we could pay for the house with cash, selling stocks. I could pay off my $400k mortgage with my Roth, and pay no taxes, but it makes no sense with a 2.75% mortgage. This has nothing to do with the OPs post. I believe the concept was what some early posters suggested in that cheap loans were available for stock purchases (margin or otherwise) that were never sold until death, or against a huge loss.

 

[ychuck46]

If you are trying to avoid taxes on appreciated stock, the key is never to sell that stock, not what you are saying this financial "advisor" is telling you. By taking loans you pay back over a longer period of time and hopefully can use other assets that have not appreciated to pay back the loans, avoiding capital gains.

 

[Oakster]

Is this any different than investing in the stock market while you still have a mortgage? In essense, you are borrowing against your home (instead of paying off your debt) and investing. There are lots of reasons to keep the stock, some of them are about taxes, some are about staying invested for EARNING POTENTIAL and some are about ownership shares, sending messages to stockholders if you sell, voting rights etc.

To put it in a nutshell, it is taking out a loan leveraged against your assets, no different than a HELOC , a second mortgage etc.

The more I think about it, why is it any different than taking out a car loan to buy a car instead of selling stock to pay for the car? Dont we all do this?

 

[Oakster]

Our neighbor, a young financial advisor, told my DH the rich take out loans to avoid paying taxes. They take out loans against stock index funds. Then pay back the loans via selling the stock. Because it's a loan, you don't have to pay taxes it. Has anyone heard of this strategy? You pay interest on the loan which is less than the tax you'd pay selling the stock. Maybe this strategy is for the ultra rich who can weather a market downturn. Our neighbor, bless his heart, is always coming up with these unusual financial gimmicks. We won't give him a dime to play with, but find his financial ideas entertaining.

I just reread this and comprehended the bold line. That is not accurate. When you sell your stock, you have to pay the taxes. That is the move that generates the tax event. Of course it fits into your overall income tax scenerio.... You cant avoid the tax from selling the stock in most instances, and I dont know how you could avoid it by taking out a loan. The taxes are generated at the sale, regardless of what you do with the proceeds.

 

[davidfin]

I just reread this and comprehended the bold line. That is not accurate. When you sell your stock, you have to pay the taxes. That is the move that generates the tax event. Of course it fits into your overall income tax scenerio.... You cant avoid the tax from selling the stock in most instances, and I dont know how you could avoid it by taking out a loan. The taxes are generated at the sale, regardless of what you do with the proceeds.

Often it can be as simple as timing, pushing off the taxable event until a more tax friendly time.

 

[copyright1997reloaded]

While I am certainly not in the ultra-rich, I used a scaled down version of this technique this year when I bought a new place (and still have my old place). I have a decent slug of Apple w/a low cost basis (in the 35 cent range) (purchased in 2001). I had some cash in non-tax-deferred acounts but not enough to close on the property. I would have sold some of the Apple stock, or pulled $ from a traditional IRA, but I am skating dangerously close to yet another IRMAA level, additional NIIT and perhaps a higher marginal bracket.

So I did a few things:
1) Borrowed on Margin, but wrote a collar on some Apple that would allow me to defer selling it until 2025 tax year (wrote Jan 25 240 calls, bought Jan 25 220 puts, net proceeds $5 share when stock was $232 or so. Max proceeds if stock rose would be 240+5 = 245 net to me, lowest if stock fell would be 220+5 =225 to me).
2) Borrowed cash from Roth, 60-day rollover while waitng for a few CD's to mature.

Between the two above I've managed the risk and can defer taxes until 25. Theoretically I can re-do this with a Jan 26 date, etc. (I will likely not because in general I am too chicken sh*t to stay on margin for a long period).

Next year (tax year 2025) my income will be lower (no more full time j*b or retirement sick bank payout) so I can get more income (e.g. IRA distribution or stock sale) to reduce my need to do this.

No way would I do such a strategy unless I had greatly appreciated stock - a margin call is an bad experience - I had a friend almost wiped out in 1987 due to margin).

Also, this ultra-rich technique was fueled by super low interest rates. While it can (and is) still done, the breakeven calculations aren't as good.

 

[njhowie]

It's a margin loan and will result in lower capital gains taxes on appreciated investments.

However, it's not a strategy to lower taxes. It is a mechanism for leveraging - which has its benefits as well as drawbacks. It's not all one-sided benefits.