The ultra-wealthy, flush with cash accumulated since the pandemic started, have begun financing some purchases with “bank of me” loans that use securities as collateral.
This move also comes with surprisingly few tax repercussions—when executed correctly. Many of the biggest players on Wall Street, including giants like Goldman Sachs, Morgan Stanley and BofA Merrill Lynch, are rapidly growing their lending business, gaining access to a new group of affluent investors in the process.
Well-placed sources said these firms are willing to lend against up to 60% or 65% of a client's portfolio, depending on its level of risk. Morgan Stanley and Merrill are lending mostly to their proprietary clients, though Goldman is building a significant business with RIAs and independent brokers.
“If an individual has a liquid portfolio of stocks or bonds held at a broker-dealer, bank or wirehouse, they can use a pledged account loan to borrow against the portfolio and not have to sell securities to obtain liquidity,” said Howard Sharfman, senior managing director at NFP Insurance Solutions in Chicago.
“The securities are used as the collateral for the loan,” said attorney Toby Mathis, founding partner of the Anderson Law Group and manager of its Las Vegas office. And “not just the ultra-wealthy: anyone who wants to access low-interest cash without incurring capital gains and, more importantly, giving up the growth of the securities.”
Though simple in concept, these loans can turn risky. A falling market could mean a borrower has a margin call. Some also see securities-based lending as a conflict of interest in the broker-client relationship, potentially driving brokers and RIAs to recommend something that can be detrimental to clients’ long-term wealth preservation and growth.
“Using leverage of any type adds risk to the portfolio,” Sharfman said. “Clients need to think before they leverage anything and make sure that a major draw down in the portfolio can still support the pledged account loan.”
“As with all borrowing strategies, the rate of interest charged is based on the borrowers’ credit worthiness and the assets pledged as collateral,” Cordasco said. “It is important to understand your risk if assets’ values decline.”
These borrowing strategies are no different than using a home equity line of credit to access accumulated equity in your house, said Rob Cordasco, a CPA and founder of Cordasco & Company in Savannah, Ga.
Clients can use a wide variety of strategies to access cash by leveraging assets they own without triggering taxes. “The simplest form is ‘borrowing on margin’ through your investment account or borrowing against the cash value in your life insurance policy,” Cordasco said. But understanding the terms of the borrowing is key, he added.
Finra reports that margin loans on securities have grown some 60% since January 2020. The lack of tax wrinkles only increases these loans’ appeal.
“The S&P 500 has averaged 13%-plus for the last 10 years while interest rates are close to 3%. When you borrow against your portfolio, you’re paying the lower interest rate while receiving the higher interest rate,” Mathis said.
“The punch line for all of these strategies is that the gains on your stock and real estate portfolio will likely never be taxed,” Mathis said. “Because if you do not sell the asset securing the loan, the cost basis of the security or real estate will step up to the fair market value of the security or real estate on the date of the owner’s passing.
“This is true even if I borrowed $350,000 against my Tesla stock,” he added. “Not only would I never pay tax on the gain, but I wouldn’t pay tax on the $350,000 I borrowed. For the ultra-wealthy, these numbers are relevant on a much larger scale. Elon Musk owns billions of dollars in Tesla stock and could borrow, quite literally, billions of dollars using his stock as collateral without paying a penny in taxes.”
This works particularly well with a long-term plan, in what Mathis noted is sometimes called a “buy-borrow-die” strategy.
“A tax isn’t triggered until an event occurs—usually the transfer of ownership. Financing arrangements are set up to gain access to accumulated profits without transferring ownership,” Cordasco said.
“The client doesn’t have to sell appreciated assets and pay tax on the gain. If the client holds the assets [until] death, the assets receive a stepped-up basis and there is never a tax paid. The assets can then be sold to pay off the loan,” Sharfman said. “Many clients also purchase life insurance that can be used to pay off the pledged account loan.”
