Living off of margin loans

[ERD50]

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 answered the step-up question, but I still wondered if the loan was owed by the estate, and had to be paid with funds from the estate that were not stepped up?

I don't think so, when a person passes, everything they owned is now tied to their EIN and not their old SSN, so I guess the EIN/Estate gets the step up, and pays off the loan with no/little cap gains? Pretty sure that's how to look at it.

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 ? ....

That's why you approach this carefully. Like some others, when SS/Pensions/RMDs kick in, I expect to have more 'forced' taxable income than I would spend, so I'll pay it off over time with those funds (not by selling stock and having a cap gains hit). The loan balance will be dropping over time.

Being careful, I'm not taking out a large % of the portfolio, so it is unlikely I would ever "have to pay it off" in one year. Heck, even if I got a margin call, you only need to put in enough to get you back to the limits that are set, you don't have to pay off the whole thing.

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.

DO NOT USE A KITCHEN KNIFE! DO NOT DO IT! You could get hurt!

Debt is a tool. Use it wisely and you can benefit. Or pass up the opportunity if you don't like it, that's OK too. But do it as an informed decision.

It's hard to see how someone could go broke in 3 years taking out $250K loans once a year and paying them back each year, on a $5M portfolio. Are you sure? Can you show the math? 40% of $5M still leaves $2M. $2M >> $250K.

-ERD50

 

[Time2]

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.

Do you think it might be different if you borrowed $50k a year for 5 years on a $2.5M portfolio? Then pay it back with excess income from dividends. SS and RMDs.

 

[Markola]

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.

OMG. Sorry for your partner to hear this cautionary tale. Can you provide more detail to show how this cascade can happen? As I understand it, $5 million became $3 million in the downturn, then $250K to pay back one loan, and $250k to pay for that year’s lifestyle, so $2.5 million. How did the rest evaporate, if you don’t mind sharing?

 

[2177V]

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

I agree. You can play these games when you are young. However when I get older, I am not as sharp as I was. You read news stories about the elderly being swindled by con men who understand older folks are easy prey. Similarly when you decide to play a complicated game like living on margins you can easily make a mental mistake that can cost you big time. I am 70 now and sleep in vital for longevity. Worrying about a margin call does not make sense for older retired folks. IMO.

 

[ivinsfan]

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.

Is ML who I think it is. Why would they convince him

 

[ncbill]

OMG. Sorry for your partner to hear this cautionary tale. Can you provide more detail to show how this cascade can happen? As I understand it, $5 million became $3 million in the downturn, then $250K to pay back one loan, and $250k to pay for that year’s lifestyle, so $2.5 million. How did the rest evaporate, if you don’t mind sharing?

Yep, $250k on a $5 million portfolio is only 5% of the portfolio.

Hard to see how that would ever trigger a margin call, even back in the Great Recession, on a diversified portfolio.

Now, if they bet everything on one sector, or worse one stock...

 

[RetiredHappy]

Yep, $250k on a $5 million portfolio is only 5% of the portfolio.

Hard to see how that would ever trigger a margin call, even back in the Great Recession, on a diversified portfolio.

Now, if they bet everything on one sector, or worse one stock...

Only possible if it was all Enron.

 

[2177V]

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.

Paying interest on accrued sounds dangerous after 10 years. Most investors understand that your investment value “escalate” or increases expontentially because you are earning interest or additional market returns on your yearly profits. IMO you will be charged interest on your accrued interest so your debt will escalate or increase expontentially. A minor issue the first 10 years but afterwards it can be a big issue due to the expontential effects. Have you calculate how this system impact your total savings after 20 years or after you reach age 90 which is 10 years more than your life expectancy?

Another problem I see is what happens if we have double digit inflation in the next few years and the interest that you may be paying is 12% in a year for example and then another 13% the following year on that previous 12% interest that has accrued. Never underestimate the effects of compounding. Just ask people who have a large credit card debt and are paying double digit interest on their debt. Sounds like a “debt trap” IMO.

 

[jazz4cash]

Is ML who I think it is. Why would they convince him

ML gets interest payments and very often margin loans are used to acquire more securities or other revenue generating activity

 

[jazz4cash]

Is there any way to to take a margin loan from a lender that does not have custody of the assets securing the loan? I have a portfolio at Fidelity but the margin rates are 6.75%. I see others charge .65% but I’d leave the assets with Fido if I could somehow.

 

[ivinsfan]

ML gets interest payments and very often margin loans are used to acquire more securities or other revenue generating activity

Well I don't think you can blame ML for someone taking margin loans

 

[geeky_grrl]

Another problem I see is what happens if we have double digit inflation in the next few years and the interest that you may be paying is 12% in a year for example and then another 13% the following year on that previous 12% interest that has accrued. Never underestimate the effects of compounding. Just ask people who have a large credit card debt and are paying double digit interest on their debt. Sounds like a “debt trap” IMO.

Unlike credit card debt trap, I would have appreciating assets the same time as increasing debt. I think the relative rates of appreciation vs. interest are more important than the absolute interest rate. If the interest rate is 12% but the market increased in value by 15% I would still be ahead by borrowing against my assets instead of selling my assets and I would lose if there is a prolonged bear market even with more modest interest rates.

I probably need to write some code to do more testing against historical market conditions. 70s-80s style stagflation of high interest rates plus poor market returns would be painful.

 

[Sunset]

Is there any way to to take a margin loan from a lender that does not have custody of the assets securing the loan? I have a portfolio at Fidelity but the margin rates are 6.75%. I see others charge .65% but I’d leave the assets with Fido if I could somehow.

Not that I know of.
The entire reason a person can get a margin loan, is because the lender has the ability to sell off the stocks if the margin ratio gets too high and needs to be fixed by a margin call.
So a margin lender wants the money where they can see it

 

[tb001]

Unlike credit card debt trap, I would have appreciating assets the same time as increasing debt. I think the relative rates of appreciation vs. interest are more important than the absolute interest rate. If the interest rate is 12% but the market increased in value by 15% I would still be ahead by borrowing against my assets instead of selling my assets and I would lose if there is a prolonged bear market even with more modest interest rates.

I probably need to write some code to do more testing against historical market conditions. 70s-80s style stagflation of high interest rates plus poor market returns would be painful.

I would be very interested in seeing the outcome of this modeling. The main worry that I have is exactly this scenario. And perhaps amplifying your sorr? But savings on aca and taxes could be significant enough to offset this.

My other concern is that while it seems easy now, when ibkr has super low rates, what happens if they decide to have more traditional margin loan rates. The other brokers have these in the 4-6% range it seems. Theoretically the numbers still work but it’s a smaller margin of error.

 

[SecondCor521]

I would be very interested in seeing the outcome of this modeling. The main worry that I have is exactly this scenario. And perhaps amplifying your sorr? But savings on aca and taxes could be significant enough to offset this.

My other concern is that while it seems easy now, when ibkr has super low rates, what happens if they decide to have more traditional margin loan rates. The other brokers have these in the 4-6% range it seems. Theoretically the numbers still work but it’s a smaller margin of error.

Another concern would be the broker changing not just the margin rate, but the margin call requirements. I think, but am not certain, that they can do this unilaterally and on short notice. It would of course depend on the margin agreement.

 

[tb001]

Another concern would be the broker changing not just the margin rate, but the margin call requirements. I think, but am not certain, that they can do this unilaterally and on short notice. It would of course depend on the margin agreement.

Yes. I think the fine print says they are not even technically required to give you notice. That said, I haven’t heard of a situation like this happening. We did a somewhat shallow dive into doing this and then got scared off by the terms. I think this is an easy call if your living off a small % of your portfolio and can easily pivot if it starts to go sideways. Harder if you’re closer to the 3% mark. But I’d love to see real math for some of the challenging times.

 

[NW-Bound]

Is there any way to to take a margin loan from a lender that does not have custody of the assets securing the loan? I have a portfolio at Fidelity but the margin rates are 6.75%. I see others charge .65% but I’d leave the assets with Fido if I could somehow.

Not that I know of.
The entire reason a person can get a margin loan, is because the lender has the ability to sell off the stocks if the margin ratio gets too high and needs to be fixed by a margin call.
So a margin lender wants the money where they can see it

Right.

The only way the lending brokerage can feel secure is to have its grubby fingers on your "assets" at all times, so that it can excise them promptly when such action is deemed necessary.

 

[4legsgood]

Here's a case of IBKR changing initial margin requirements.

https://www.investopedia.com/interactive-brokers-raises-margin-requirements-5079138

 

[2177V]

Unlike credit card debt trap, I would have appreciating assets the same time as increasing debt. I think the relative rates of appreciation vs. interest are more important than the absolute interest rate. If the interest rate is 12% but the market increased in value by 15% I would still be ahead by borrowing against my assets instead of selling my assets and I would lose if there is a prolonged bear market even with more modest interest rates.

I probably need to write some code to do more testing against historical market conditions. 70s-80s style stagflation of high interest rates plus poor market returns would be painful.

When interest rates are high, the market takes a hit so there is a good chance of a recession. This means your assets may decline plus you are paying high interest rates. When your assets decline in value during that recession…then that is a time when margin calls begin by the financial institutions in order for them to stay solvent and you are forced to sell your assets after your assets have declined. You may not control that situation.

I always prefer to sell high and not sell low. Going by historical market testing is also risky because of the old saying: “past historical examples do not guarantee future results”. Do you have a backup plan if the worst case happens if both declining assets and exploding interest rates on your accrued interests? No offense. I am just playing devil advocate to make sure you have thought this out. If you are committed to this plan and you fully understand ALL of the risks, then good luck with this plan.

My plan is to avoid debt and sell my assets when they are high. Remember to “buy low and sell high”. Never “sell low”. If I do need to borrow, I will borrow money from a bank with a FIXED interest rate. People who had jumped out of the window in a tall building during the 1930’s are the ones who borrowed money to put that money in the stock market and then the market crashed. In a sense, you are doing something similar in that you are borrowing money against your assets to avoid a declining nest egg which means you are investing in the market on “borrowed money”.

 

[jazz4cash]

Not that I know of.
The entire reason a person can get a margin loan, is because the lender has the ability to sell off the stocks if the margin ratio gets too high and needs to be fixed by a margin call.
So a margin lender wants the money where they can see it

Yeah I get that. Wishful thinking that maybe they could place a lien on the assets but that would put custodian in an awkward position.

 

[jazz4cash]

Well I don't think you can blame ML for someone taking margin loans

Huh? I was responding to a question about why ML would encourage a client to use margin.

 

[l8_apex]

Is there any way to to take a margin loan from a lender that does not have custody of the assets securing the loan? I have a portfolio at Fidelity but the margin rates are 6.75%. I see others charge .65% but I’d leave the assets with Fido if I could somehow.

Just call Fidelity and ask them to give you a more competitive rate. Perhaps quote a respectable competitor's rate. If the 0.65% is from where I think it is, they're not in the "respectable" category of brokerages.

 

[ivinsfan]

Huh? I was responding to a question about why ML would encourage a client to use margin.

I was responding to a poster that said ML "convinced" a friend to margin loan....semantics I guess, would hate to think ML would pressure someone to go on margin loans. Maybe that is naive on my part.

 

[geeky_grrl]

Just call Fidelity and ask them to give you a more competitive rate. Perhaps quote a respectable competitor's rate. If the 0.65% is from where I think it is, they're not in the "respectable" category of brokerages.

Rates do seem negotiable. When I moved some assets from Schwab to IB a Schwab rep called to ask why. When I mentioned margin rates he said he could request a lower rate than their standard. I declined because I have additional reasons for moving my money so I don't know what rates would be available.

 

[RetiredHappy]

I was responding to a poster that said ML "convinced" a friend to margin loan....semantics I guess, would hate to think ML would pressure someone to go on margin loans. Maybe that is naive on my part.

When we had our funds with ML, and I needed a couple of hundred thousands dollars to help my son buy his home so that he could move out before I listed my home for sale, my ML FA asked me to use LMA to pay for his home instead of selling positions. It made a lot of sense as he explained to me that HELOC application was a pain. The moment my home got sold, I paid off the LMA and closed it.

At end of last year when we were trying to buy a another home before selling off ours, my ML FA ran various scenarios with us. If we want to pay 100% cash, we could use some combination of LMA and a mortgage. In the end, I had cold feet about having 2 homes and decided to sell first before buying a new home or to make it concurrent closing. LMA is suitable for short term cash flow needs.