How to Avoid Paying Taxes if You're UHNW [Ultra High Net Worth]

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SpaceCowboy
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How to Avoid Paying Taxes if You're UHNW [Ultra High Net Worth]

Post by SpaceCowboy »

In another thread I mentioned this strategy covered in Forbes for avoiding taxes including cap gains if you're UHNW. To implement you need to get a low cost portfolio loan which are available from the large depository banks with brokerage services, e.g. JP Morgan Chase, UBS etc.
http://www.forbes.com/sites/kotlikoff/2 ... 0417ea6f06
Phil DeMuth
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Phil DeMuth »

Is anyone here doing this? Please share your experience.

I follow the zero-dividend stock path but have not yet borrowed money against the portfolio for tax-free income. I do carry a mortgage on my house, which amounts to the same thing.

Most brokerages charge a fortune for what I see as nearly riskless margin loans. If Fidelity and Schwab want 6% - 8% from their customers, I can only imagine what JP Morgan extracts from its Wealth Management clients. But Interactive Brokers only wants 1% - 2%, the best deal I have seen in town.

Since I write about this, please feel free to private message me. Thanks for sharing!
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SpaceCowboy
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Re: How to Avoid Paying Taxes if You're UHNW

Post by SpaceCowboy »

These are not margin loans. Interactive Brokers has the lowest margin rates.
These are portfolio loans, they offer a higher LTV and cannot be used to purchase securities. Schwab offers a retail version of thishttps://www.schwab.com/public/schwab/ba ... asset_line, but the bulge brackets offer this to UHNW at much lower rates like Libor + 100bps, just a guess. It's especially suitable for elderly UHNW investors, as they can completely avoid the cap gains hit due to the set-up in basis when the assets pass to heirs and the loan value reduces the value of the state subject to estate/inheritance taxes.
bberris
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Re: How to Avoid Paying Taxes if You're UHNW

Post by bberris »

Anyone tried to negotiate their margin rates at one of these brokerages by holding an ad from IB? Scottrade charges 8 %. I always intended to use my taxable account to fund retirement. Unfortunately, I now have too much capital gains :D to make sufficient withdrawals without risking the obamacare cliff.

I'm not so sure if these loans are really riskless for the broker. Sure if you have a lot of equity in a diversified portfolio (like me!) the broker is unlikely to lose. But there are some characters out there making some real wild-ass bets that could come chest up.

Incidentally, if you are staying below the obamacare cliff. you are taxed an extra 9.6 % loss of subsidy on capital gains, tax free bond income, etc. Although I am adverse to debt, I think I could maintain withdrawals through borrowing until Medicare.
Rotarman
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Rotarman »

I don't understand. Wouldn't the assets have to be liquidated (and taxed) upon death? I can't imagine how an heir could be liable for the deceased's debts. If the heir isn't liable, it doesn't make sense for the bank to let the assets pass to the heir, wait for the stepup, then hope the heir pays up.
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CAsage
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Re: How to Avoid Paying Taxes if You're UHNW

Post by CAsage »

Estates have to pay the bills before the heirs get the goodies.
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afan
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Re: How to Avoid Paying Taxes if You're UHNW

Post by afan »

I can see how this could work for someone with assets that vastly exceed their needs for income. One would have to do the math to be sure that the cost of interest on the loan, which compounds, is still less of a drag than simply investing in munis and a broad stock portfolio that includes dividends. You would pay taxes on the dividends but you would not have a constantly increasing debt. Delaying the capital sales until after the stepped up basis is appealing, but perhaps only for those who have a large share of their assets in a small number of low basis issues.

If you founded a company and took it public years ago this might apply. People who work for big corporations and got paid stock for decades, perhaps.

But loan interest might be overlooked as one focusses on avoiding taxes now, even if the heirs end up with less once the debt is paid.

There is also a bird in the hand trade-off. If you sell stock then you realize the full value after tax. If you borrow, your stock can go down by a lot more than the capital gains taxes that would have been triggered by a sale. That is why you need assets many many times what you are borrowing. So there is no chance of being hit with a demand for payment after 20 years of compounding interest and then a 60% drop in stock.
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Phil DeMuth
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Phil DeMuth »

A few random comments:

1) As an investment advisor, I have been able to negotiate lower margin rates for clients by showing lower rates elsewhere. I imagine that a retail investor could do the same, provided s/he had a big account and was threatening to move it across the street.

2) The brokerages analyze every security in your portfolio and limit their margin lending against each one individually. Believe me, they give themselves a wide margin of safety because they force you to sell (or will sell on your behalf if you do nothing) to maintain that ratio.

3) Your heirs do not end up with less money via this strategy, because if you sold the stock along the way they would be out the value of the stock, the future compounding, plus the taxes. For the UHNW, those taxes are a minimum of 25% (bracket CG rates + Obamacare + Pease Limitations + Personal Exemption Phaseouts); here in CA, they pay 33% after state taxes are tacked on (and most UHNW investors live in high-tax states). That provides a lot of wiggle room to arbitrage the compounding of the loan vs. the compounding of the portfolio.

4) The rich get richer: the underlying portfolio is a levered, long-term holding, getting the returns of stocks for the long run, only juiced. When you consider that the ideal holding for a portfolio like this is a company like Berkshire Hathaway (itself a levered, low-beta, zero-dividend investment) you can see how the tax-efficiency of this approach coupled with the excellent long-term returns make this a win-win.
randomguy
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Re: How to Avoid Paying Taxes if You're UHNW

Post by randomguy »

afan wrote: There is also a bird in the hand trade-off. If you sell stock then you realize the full value after tax. If you borrow, your stock can go down by a lot more than the capital gains taxes that would have been triggered by a sale. That is why you need assets many many times what you are borrowing. So there is no chance of being hit with a demand for payment after 20 years of compounding interest and then a 60% drop in stock.
That is why you start doing things like exchange funds (diversify out of your single stock while postponing capital gains) and pay for hedges. Obviously the question is always is this stuff more or less expensive than just paying taxes.

I haven't run the math but my gut says that these type of schemes work best in todays low interest rate world. Start having to pay a compounding 7% on your living expenses sounds like it good get expensive.
bberris
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Re: How to Avoid Paying Taxes if You're UHNW

Post by bberris »

Phil DeMuth wrote:A few random comments:

...

2) The brokerages analyze every security in your portfolio and limit their margin lending against each one individually. Believe me, they give themselves a wide margin of safety because they force you to sell (or will sell on your behalf if you do nothing) to maintain that ratio.

....
Then there was this purported ill-timed KaloBios trade:

http://www.businessinsider.com/joe-camp ... de-2015-11

If that story is true ( I doubt it) the broker messed up that one.

Do discount brokers really have the resources to analyze each account? (maybe some AI - equipped program.)
Tanelorn
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Tanelorn »

Interactive brokers is the best by far in terms of margin rates available to retail investors. Ultra high net worth investors I can only imagine they would rapidly hit the top tier, which charges less than 0.7%.

https://gdcdyn.interactivebrokers.com/e ... php?f=1595

I've negotiated margin rates with many brokers and while they are often willing to do much better than the headline 6-8% rates for larger or more active accounts, none of them have been as low as Interactive.

Anyone facing their own mortality should certainly think twice before selling an appreciated asset. With interest rates at only 1%, the interest on a portfolio loan would compound quite slowly over time, compared to taxes could easily be a quick 1/3 hit if most of the present value was appreciation. That said, this approach only works if the tax liability dies with the owner, and while this is true for current estate tax law, that may not survive the upcoming election.
edge
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Re: How to Avoid Paying Taxes if You're UHNW

Post by edge »

These are not margin loans. This is called securities based lending. It is a useful tax avoidance strategy.
bberris
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Re: How to Avoid Paying Taxes if You're UHNW

Post by bberris »

edge wrote:These are not margin loans. This is called securities based lending. It is a useful tax avoidance strategy.
Call it anything you want, its a margin loan. Its kind of like when whole life got a bad name, they started marketing it as bank on yourself. Whether you buy the securities first with cash, and then get a loan cash out, or buy securities using a loan at the time of purchase, you end up in the same place. The same regulations apply.
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Watty
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Watty »

One risk with this is that the rules about the "stepped up cost basis" could change and so I would be cautious about assuming that this will not change for several decades. There are lots of permutations but you could even get a quadruple whammy and pay interest for years, have your investments not keep up with the interest, lose the stepped up cost basis, and the capital gains tax rate could be higher in the future.

Talking politics is discouraged here but you can search the internet to see some of the proposals that have been proposed to eliminate the stepped up cost basis.
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dodecahedron
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Re: How to Avoid Paying Taxes if You're UHNW

Post by dodecahedron »

Ed McCaffery, a professor of tax law at USC, has dubbed this strategy the "buy, borrow, die" strategy and discusses it in greater detail in this book. It is not a strategy I'd personally be comfortable with, but then again I am not UHNW.
Park
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

Phil DeMuth wrote:Is anyone here doing this? Please share your experience.
No, I'm not doing it, but it's part of my plan. PE10 of the US stock market is about 26.5. In 1966, it reached a peak of about 25. What gets my attention is that the 1966 peak was followed by a secular bear market that ended in 1982.

How to survive such a secular bear market? Bonds work for a cyclical bear market. But when you look at the data from the 1968-1982, bonds didn't help. And my tax on bonds is around 45%.

1968-1982 real returns

S&P 500 -0.31%
5Yr Treas 0.26%
Tbills 0.09%
LT Treas -1.70%
LT Corp -1.22%
CPI-U 7.30%

So one option to deal with a secular bear market is to generate income using tax free loans against my portfolio. There is the interest on those loans, but it might be considerably less than the tax on such income.

P.S. At the highest margin rate at IB, you're paying 1.91%. That 1.91% is the benchmark plus 1.5%. The benchmark is the Federal Funds overnight rate. The federal funds overnight rate reached a peak of around 19% in 1981, and it was a very short peak. Regardless, 20.5% is less than an UHNW individual would likely pay in tax. Based on the history of the Federal Funds overnight rate, it would take quite a bit of compounding over the years to make borrowing to generate income an unattractive option.
arf30
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Re: How to Avoid Paying Taxes if You're UHNW

Post by arf30 »

So the broker lends you money and holds your stocks as collateral, but you can't actually give those stocks to the broker to repay the loans without selling the stock and incurring captain gains, right? Or am I missing something? Eventually you'll have to pay the broker back somehow.
bberris
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Re: How to Avoid Paying Taxes if You're UHNW

Post by bberris »

I guess the confusion results from a question that I don't know the answer to.

When you die, can you pass the entire portfolio to your heirs with the margin debt attached? In that case, your heirs get the step up basis and don't pay capital gains tax. On the other hand, if the debt has to be paid by the estate before the securities go to the heirs, there does not seem to be a tax advantage since the estate presumably has the high tax bracket of the decedent.
ralph124cf
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Re: How to Avoid Paying Taxes if You're UHNW

Post by ralph124cf »

Park wrote:
Phil DeMuth wrote:Is anyone here doing this? Please share your experience.
No, I'm not doing it, but it's part of my plan. PE10 of the US stock market is about 26.5. In 1966, it reached a peak of about 25. What gets my attention is that the 1966 peak was followed by a secular bear market that ended in 1982.

How to survive such a secular bear market? Bonds work for a cyclical bear market. But when you look at the data from the 1968-1982, bonds didn't help. And my tax on bonds is around 45%.

1968-1982 real returns

S&P 500 -0.31%
5Yr Treas 0.26%
Tbills 0.09%
LT Treas -1.70%
LT Corp -1.22%
CPI-U 7.30%

So one option to deal with a secular bear market is to generate income using tax free loans against my portfolio. There is the interest on those loans, but it might be considerably less than the tax on such income.

P.S. At the highest margin rate at IB, you're paying 1.91%. That 1.91% is the benchmark plus 1.5%. The benchmark is the Federal Funds overnight rate. The federal funds overnight rate reached a peak of around 19% in 1981, and it was a very short peak. Regardless, 20.5% is less than an UHNW individual would likely pay in tax. Based on the history of the Federal Funds overnight rate, it would take quite a bit of compounding over the years to make borrowing to generate income an unattractive option.
As you mention, the income tax is more than the interest even at 20.5%, but that interest rate compounds every year. If the interest rate stayed anywhere above 10%, as it has done several years since 1980, then this would be a losing strategy compared to selling and paying the tax.

Ralph
Park
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

ralph124cf wrote:
Park wrote:
Phil DeMuth wrote:Is anyone here doing this? Please share your experience.
So one option to deal with a secular bear market is to generate income using tax free loans against my portfolio. There is the interest on those loans, but it might be considerably less than the tax on such income.

P.S. At the highest margin rate at IB, you're paying 1.91%. That 1.91% is the benchmark plus 1.5%. The benchmark is the Federal Funds overnight rate. The federal funds overnight rate reached a peak of around 19% in 1981, and it was a very short peak. Regardless, 20.5% is less than an UHNW individual would likely pay in tax. Based on the history of the Federal Funds overnight rate, it would take quite a bit of compounding over the years to make borrowing to generate income an unattractive option.
As you mention, the income tax is more than the interest even at 20.5%, but that interest rate compounds every year. If the interest rate stayed anywhere above 10%, as it has done several years since 1980, then this would be a losing strategy compared to selling and paying the tax.

Ralph
For me, the best income is selling some stocks. Cap gains tax is less than my other tax rates. And I only have to pay tax on my gains; there's no tax on the money I spent to buy the stocks. The other costs, such as commissions and bid ask spreads, are small. Finally, I can precisely control the timing and amount of income that I want.

This may break down in a bear market. By selling stocks in a bear market, I may end up losing money or having a lower rate of return than I want. So I may want to look at another way of generating income, other than selling stocks. One option in a bear market is borrowing to create income. As you mention, compound interest at 10%+ will add up. But if it literally buys me enough time to let the the stock market recover, it could be a winning strategy.
Tanelorn
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Tanelorn »

This talk about 10-20% interest rates makes me laugh. The Fed has barely managed to find the guts to raise 0.25%/year and the majority of the Fed board is siding with Yellen on continued low rates. The government budget looks like 20T reasons to keep rates low, but that's just my $0.02 worth.

In any event, if this is a useful approach for your situation, you can start out with a 1% margin loan and see how it goes. If rates stay low, your costs are almost nothing and you wait and see. If rates start to rise, you can always reconsider, sell some appreciated stocks, pay your taxes and pay off the loan. Since rising rates tend to go with falling stock markets, the latter case may not be as expensive as you might think since some of your gains might have been reduced.
randomguy
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Re: How to Avoid Paying Taxes if You're UHNW

Post by randomguy »

arf30 wrote:So the broker lends you money and holds your stocks as collateral, but you can't actually give those stocks to the broker to repay the loans without selling the stock and incurring captain gains, right? Or am I missing something? Eventually you'll have to pay the broker back somehow.
That is the basic summary. You pay the broker back when you die. The math is something like
Estate assets 50 million (cost basis of 0)
Estate liabilities 40 million.
Estate sells 50 million in stock. Writes a check for 40 million to the banks and gives 10 million to the heirs. 0 taxes get paid. Obviously that is really simplified (i.e. the banks are going to want a lot more protection).

The question is do you end up with more money by paying the banks interest for x years or by paying the government their 25%+? That requires a ton of guesses and assumptions. The closer you are to the end game, the easier it is to make accurate assumptions.
Phil DeMuth
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Phil DeMuth »

Is the math more complicated than this?

Margin/"Portfolio" Loan: total loan amount compounded at 1%-2%

vs.

Sell Stocks and Pay Cap Gains: 25% of capital gains + total value of stocks sold (foregone opportunity cost) compounded at the returns of the stock market.

If your long-term portfolio returns are higher than 1%-2%, you would be better off borrowing the money.

Or am I missing something?
Park
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

Phil DeMuth wrote:Is the math more complicated than this?

Margin/"Portfolio" Loan: total loan amount compounded at 1%-2%

vs.

Sell Stocks and Pay Cap Gains: 25% of capital gains + total value of stocks sold (foregone opportunity cost) compounded at the returns of the stock market.

If your long-term portfolio returns are higher than 1%-2%, you would be better off borrowing the money.

Or am I missing something?
No, I think you nailed it.

However, I think it would be better to substitute "the interest rate" for "1-2%". Anyone using this strategy at least has to consider the possibility of considerably higher interest rates. And as mentioned previously, higher interest rates have a tendency to correlate with lower stock market returns. Also, you consider initial taxation in the "Sell Stocks and Pay Cap Gains" strategy, but it would probably be better change "compounded at the returns of the stock market" to "compounded at the aftertax returns of the stock market". Also, it might/might not be possible for an individual to get a tax deduction on the interest generated by the "Margin/"Portfolio" Loan strategy. At 1-2%, a deduction doesn't make much difference. But at 20%, a tax deduction of 45% would. Finally, 25% cap gains tax is presently accurate, but that could change.

But my comments are minor in nature.
edge
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Re: How to Avoid Paying Taxes if You're UHNW

Post by edge »

Um, except all the terms are different?
bberris wrote:
edge wrote:These are not margin loans. This is called securities based lending. It is a useful tax avoidance strategy.
Call it anything you want, its a margin loan. Its kind of like when whole life got a bad name, they started marketing it as bank on yourself. Whether you buy the securities first with cash, and then get a loan cash out, or buy securities using a loan at the time of purchase, you end up in the same place. The same regulations apply.
Tanelorn
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Tanelorn »

edge wrote:Um, except all the terms are different?
In what way do you think securities based lending terms are different than margin terms? For the securities based lending account I have, the rate is a spread to a short term, floating rate index (similar to margin), and they will give you the equivalent of a margin call if your equity ratios drop below some maintenance amount. They won't sell you out quite as fast as IB will with their automated system, but it's similar to a traditional margin call where you might have a week to address it if they aren't worried and less if they are. Either way, they reserve the right to sell the assets to protect themselves and stick you with the tax consequences. Are there some other differences you think are important?
randomguy
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Re: How to Avoid Paying Taxes if You're UHNW

Post by randomguy »

Tanelorn wrote:
edge wrote:Um, except all the terms are different?
In what way do you think securities based lending terms are different than margin terms? For the securities based lending account I have, the rate is a spread to a short term, floating rate index (similar to margin), and they will give you the equivalent of a margin call if your equity ratios drop below some maintenance amount. They won't sell you out quite as fast as IB will with their automated system, but it's similar to a traditional margin call where you might have a week to address it if they aren't worried and less if they are. Either way, they reserve the right to sell the assets to protect themselves and stick you with the tax consequences. Are there some other differences you think are important?
Margin interest is more or less tax deductible. Asset based loans aren't. And practically the amount of leverage being used is changes the equation. If you are borrowing say 4%/year from your account to live on (This would probably be very high for a person with a 50+ million dollar networth.), it is going to take a lot of years until you get leverage up to say 40%. And of course you can spend asset loans on living expenses while that isn't legal with margin loans:) I will let you decide if that means the terms are different or not.

This strategy is going to show the difference between the debt is bad people and the debt is a tool people. I would hate to try this strategy unless I was having it (and the related estate planning) all done by some professionals. Strategies like this might apply for more moderate wealth people who only need to avoid income for a short period of time. Need 25k but doing that would cost you an 8k ACA subsidy? Take out a loan for the 3 years until you turn 65. Need 100k to help buy a house but that would make you pay an added 3.8%? Take out a loan and pay it back over 2 or 3 years. Moving from CA (13%) to FL(0%) in 4 years? A loan might be a great way to go. I also have a feeling that this scheme doesn't seem anywhere near as appealing with high interest rates
Phil DeMuth
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Phil DeMuth »

More random thoughts:

It looks like there is a difference between portfolio "T.I.M.S." margin and ordinary "Reg T" margin. Portfolio margin can result in higher margin limits depending on how the performance of the underlying securities might offset each other as they zig and zag. This is all according to a rules-based mechanical system that classifies every investment without a great deal of finesse. Anyone using this strategy for ongoing living expenses should have an enormous margin of safety. If they are concerned with having to optimize the last % of margin availability, they are already in trouble.

Interest that is not used to purchase securities (or even that is used to purchase tax-free municipal bonds) cannot be deducted as an investment expense. So that piece is off the table for the UHNW investor looking to generate income instead of to buy more stocks.

The issue of underlying interest rates is important but does not lead to any easy answers. Today's super-low rates make this strategy advantageous. However, stocks can do well in both rising and falling interest rate environments. They can also do poorly in both environments. A lot of this depends on whether the changes are foreseeable or if they are wild and unanticipated (i.e., what is driving the change in rates). A related issue is inflation. Of course, to a borrower, inflation is a great friend, since it means you are paying back the expensive money you borrowed with cheap money today. But to a stock owner, inflation can be a problem, since it can throw a wrench into business planning, and it affects different businesses differently.

I guess the upshot is that it calls for careful scenario modeling. What you really want to avoid is having to sell stocks when they are beaten down as a margin call would force you to do. It looks like this is best used as a short-term strategy to cover an emergent, otherwise tax-intensive need, or as a long-term strategy for the UHNW who can live well below their margin limits.
Tanelorn
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Tanelorn »

randomguy wrote:Margin interest is more or less tax deductible. Asset based loans aren't.
The deductibility of the interest has to do with what you use the loan for more than what the collateral is. A margin-based withdrawal, ie cashing out some equity from a fully paid up stock portfolio and leaving it now on margin, is similar to an asset backed loan. If you spend the money on personal consumption, it won't be deductible either way.
Park
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

Phil DeMuth wrote:Interest that is not used to purchase securities (or even that is used to purchase tax-free municipal bonds) cannot be deducted as an investment expense...It looks like this is best used as a short-term strategy to cover an emergent, otherwise tax-intensive need, or as a long-term strategy for the UHNW who can live well below their margin limits.
I can think of one way to make the interest on a loan used for personal consumption tax deductible. But that reflects my situation, and would be relevant to very few reading this thread.

Income generated by borrowing allows one to monetize a portfolio without selling. Such income is tax free, but eventually the portfolio on which it is based will be sold. So you're getting a tax deferral. The cost of that tax deferral is the compound interest that you pay. The greater the difference between the cap gains tax rate and interest rate, the better the return from such a strategy.

But such borrowing increases the risk of the portfolio. If every year you take out a loan equivalent to 3% of your portfolio, the loan is 34% of the worth of the portfolio after 10 years; this ignores interest.

So I would agree that it is a short term strategy. If the income required is very small relative to the portfolio, it could be a long term strategy. But if you need a very small income, is the strategy worthwhile?
rrppve wrote:If you like debt, real Private Banks offer extremely low rates...They will also offer portfolio based loans that are well below broker's call and not subject to Regulation T, as they don't characterize them as margin loans.
bberris
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Re: How to Avoid Paying Taxes if You're UHNW

Post by bberris »

Tanelorn wrote:
randomguy wrote:Margin interest is more or less tax deductible. Asset based loans aren't.
The deductibility of the interest has to do with what you use the loan for more than what the collateral is. A margin-based withdrawal, ie cashing out some equity from a fully paid up stock portfolio and leaving it now on margin, is similar to an asset backed loan. If you spend the money on personal consumption, it won't be deductible either way.
Interesting. So lets say I have 80,000 fully invested. I borrow 20,000 to buy 20,000 more securities. Tax deductible!
Now lets say I add 20,000 to the account from the bank, and buy 20,000 in securities. Next day, I withdraw the 20,000 from the brokerage account as a margin loan to pay the rent. Not tax deductible!
randomguy
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Re: How to Avoid Paying Taxes if You're UHNW

Post by randomguy »

Park wrote: But such borrowing increases the risk of the portfolio. If every year you take out a loan equivalent to 3% of your portfolio, the loan is 34% of the worth of the portfolio after 10 years; this ignores interest.
And appreciation. If your portfolio doubles over the time period, you are looking at say 15% of leverage instead of your 30%+. The obvious issues is that the numbers are largely unknowable. If market appreciation is higher than the loan interest (with all sorts of tax adjustments), you are going to come out ahead.
Park
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

randomguy wrote:
Park wrote: But such borrowing increases the risk of the portfolio. If every year you take out a loan equivalent to 3% of your portfolio, the loan is 34% of the worth of the portfolio after 10 years; this ignores interest.
And appreciation. If your portfolio doubles over the time period, you are looking at say 15% of leverage instead of your 30%+. The obvious issues is that the numbers are largely unknowable. If market appreciation is higher than the loan interest (with all sorts of tax adjustments), you are going to come out ahead.
The 3% is relative to the portfolio. If the portfolio doubles in size, so does the 3% loan.
bberris
Posts: 2064
Joined: Sun Feb 20, 2011 9:44 am

Re: How to Avoid Paying Taxes if You're UHNW

Post by bberris »

Park wrote:
randomguy wrote:
Park wrote: But such borrowing increases the risk of the portfolio. If every year you take out a loan equivalent to 3% of your portfolio, the loan is 34% of the worth of the portfolio after 10 years; this ignores interest.
And appreciation. If your portfolio doubles over the time period, you are looking at say 15% of leverage instead of your 30%+. The obvious issues is that the numbers are largely unknowable. If market appreciation is higher than the loan interest (with all sorts of tax adjustments), you are going to come out ahead.
The 3% is relative to the portfolio. If the portfolio doubles in size, so does the 3% loan.
Whoa! Don't let my broker know about that one!
edge
Posts: 3622
Joined: Mon Feb 19, 2007 7:44 pm
Location: NY

Re: How to Avoid Paying Taxes if You're UHNW

Post by edge »

Uh, in just about every way possible. Taxes, availability of funds, interest terms. Mine has a fixed rate for a multi-year time period. I am not sure where you got your loan from but it does not sound very favorable.

Tanelorn wrote:
edge wrote:Um, except all the terms are different?
In what way do you think securities based lending terms are different than margin terms? For the securities based lending account I have, the rate is a spread to a short term, floating rate index (similar to margin), and they will give you the equivalent of a margin call if your equity ratios drop below some maintenance amount. They won't sell you out quite as fast as IB will with their automated system, but it's similar to a traditional margin call where you might have a week to address it if they aren't worried and less if they are. Either way, they reserve the right to sell the assets to protect themselves and stick you with the tax consequences. Are there some other differences you think are important?
randomguy
Posts: 10592
Joined: Wed Sep 17, 2014 9:00 am

Re: How to Avoid Paying Taxes if You're UHNW

Post by randomguy »

Park wrote:
randomguy wrote:
Park wrote: But such borrowing increases the risk of the portfolio. If every year you take out a loan equivalent to 3% of your portfolio, the loan is 34% of the worth of the portfolio after 10 years; this ignores interest.
And appreciation. If your portfolio doubles over the time period, you are looking at say 15% of leverage instead of your 30%+. The obvious issues is that the numbers are largely unknowable. If market appreciation is higher than the loan interest (with all sorts of tax adjustments), you are going to come out ahead.
The 3% is relative to the portfolio. If the portfolio doubles in size, so does the 3% loan.
The amount you borrow doubles. The amount of the loan doesn't. The the simple case of a investment that goes up 10% year and you pay 2% interest every year.


year portfolio loan percent
1 1000000 30000 3
2 1100000 63660 5.787272727
3 1210000 100686 8.321157025
4 1331000 141414.6 10.6246882
5 1464100 186216.06 12.71880746
6 1610510 235497.666 14.62255224
7 1771561 289707.4326 16.3532293
8 1948717.1 349338.1759 17.9265721
9 2143588.81 414931.9934 19.35688372
10 2357947.691 487085.1928 20.65716702
11 2593742.46 566453.7121 21.83924275
12 2853116.706 653759.0833 22.91385704
13 3138428.377 749794.9916 23.89077913
14 3452271.214 855434.4908 24.77889012
15 3797498.336 971637.9398 25.58626374
16 4177248.169 1099461.734 26.32023977
17 4594972.986 1240067.907 26.9874907
18 5054470.285 1394734.698 27.59408245
19 5559917.313 1564868.168 28.1455295
20 6115909.045 1752014.984 28.646845
21 6727499.949 1957876.483 29.10258636
22 7400249.944 2184324.131 29.5168967
23 8140274.939 2433416.544 29.89354245
24 8954302.433 2707418.199 30.23594768
25 9849732.676 3008820.019 30.54722517
26 10834705.94 3340362.021 30.8302047
27 11918176.54 3705058.223 31.08745881
28 13109994.19 4106224.045 31.32132619
29 14420993.61 4547506.449 31.5339329
30 15863092.97 5032917.094 31.72721173
31 17449402.27 5566868.804 31.90291976
32 19194342.5 6154215.684 32.06265432
33 21113776.75 6800297.252 32.20786757
34 23225154.42 7510986.978 32.33987961
35 25547669.86 8292745.676 32.45989055
36 28102436.85 9152680.243 32.56899141
37 30912680.53 10098608.27 32.66817401
38 34003948.59 11139129.09 32.75834001
39 37404343.44 12283702 32.8403091

So we are at year 40 and still haven't hit 34%. Obviously the numbers change when the interest and appreciation gap change. Be a person who doesn't drastically inflate thier lifestyle (i.e. you are UHNW person are you really going to be spending 2x real in year 15 to what you did in year 1) and the increase in debt is smaller. User a smaller percent (again we are talking UHNW. I doubt bill gates for example is spending 1% per year) and it you also don't get much of a growth
Tanelorn
Posts: 2151
Joined: Thu May 01, 2014 9:35 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Tanelorn »

edge wrote:Uh, in just about every way possible. Taxes, availability of funds, interest terms. Mine has a fixed rate for a multi-year time period. I am not sure where you got your loan from but it does not sound very favorable.
Do you mind sharing your rate and/or provider? You can PM me if you prefer. My floating rate is around 2%.
Park
Posts: 735
Joined: Sat Nov 06, 2010 4:56 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

randomguy wrote:The amount you borrow doubles. The amount of the loan doesn't. The the simple case of a investment that goes up 10% year and you pay 2% interest every year.


year portfolio loan percent
1 1000000 30000 3
2 1100000 63660 5.787272727
3 1210000 100686 8.321157025
4 1331000 141414.6 10.6246882
5 1464100 186216.06 12.71880746
6 1610510 235497.666 14.62255224
7 1771561 289707.4326 16.3532293
8 1948717.1 349338.1759 17.9265721
9 2143588.81 414931.9934 19.35688372
10 2357947.691 487085.1928 20.65716702
11 2593742.46 566453.7121 21.83924275
12 2853116.706 653759.0833 22.91385704
13 3138428.377 749794.9916 23.89077913
14 3452271.214 855434.4908 24.77889012
15 3797498.336 971637.9398 25.58626374
16 4177248.169 1099461.734 26.32023977
17 4594972.986 1240067.907 26.9874907
18 5054470.285 1394734.698 27.59408245
19 5559917.313 1564868.168 28.1455295
20 6115909.045 1752014.984 28.646845
21 6727499.949 1957876.483 29.10258636
22 7400249.944 2184324.131 29.5168967
23 8140274.939 2433416.544 29.89354245
24 8954302.433 2707418.199 30.23594768
25 9849732.676 3008820.019 30.54722517
26 10834705.94 3340362.021 30.8302047
27 11918176.54 3705058.223 31.08745881
28 13109994.19 4106224.045 31.32132619
29 14420993.61 4547506.449 31.5339329
30 15863092.97 5032917.094 31.72721173
31 17449402.27 5566868.804 31.90291976
32 19194342.5 6154215.684 32.06265432
33 21113776.75 6800297.252 32.20786757
34 23225154.42 7510986.978 32.33987961
35 25547669.86 8292745.676 32.45989055
36 28102436.85 9152680.243 32.56899141
37 30912680.53 10098608.27 32.66817401
38 34003948.59 11139129.09 32.75834001
39 37404343.44 12283702 32.8403091

So we are at year 40 and still haven't hit 34%. Obviously the numbers change when the interest and appreciation gap change.
As you mention, what matters is the difference between the interest rate and the rate of portfolio growth. If they are the same, the loan will increase at the same rate as the portfolio. Your analysis assumes a difference of 8%. The lowest rate at IB is for loan balances greater than $3 million, where it's 0.66%. The 52 week T- bill rate is presently 0.62%. From "Stocks For The Long Run", US stocks have outperformed T-bills by 6.0% between 1946-2012. But that 6% difference ignores the costs and taxes associated with the portfolio return, and assumes you can borrow near the risk free rate.

At year 15 using a difference of 8%, the loan is 25% of the portfolio. Your exposure to market risk has increased. As has been mentioned previously, under present Portfolio Margin rules, the loan is very unlikely to result in a margin call in the face of a bear market. But margin rules change. Similarly, you've gotten considerable interest rate risk exposure. A generation ago this strategy would have exposed you to several years of 10+% rates. In 1981, S&P500 return was -5.33% and the federal funds rate peaked at around 19%. The risks of this strategy can show up when you least want them to.

This might work long term for an UHNW investor taking small yearly loans. But for the rest of us, I wouldn't advise it as a long term strategy.
randomguy
Posts: 10592
Joined: Wed Sep 17, 2014 9:00 am

Re: How to Avoid Paying Taxes if You're UHNW

Post by randomguy »

Park wrote:
As you mention, what matters is the difference between the interest rate and the rate of portfolio growth. If they are the same, the loan will increase at the same rate as the portfolio. Your analysis assumes a difference of 8%. The lowest rate at IB is for loan balances greater than $3 million, where it's 0.66%. The 52 week T- bill rate is presently 0.62%. From "Stocks For The Long Run", US stocks have outperformed T-bills by 6.0% between 1946-2012. But that 6% difference ignores the costs and taxes associated with the portfolio return, and assumes you can borrow near the risk free rate.

At year 15 using a difference of 8%, the loan is 25% of the portfolio. Your exposure to market risk has increased. As has been mentioned previously, under present Portfolio Margin rules, the loan is very unlikely to result in a margin call in the face of a bear market. But margin rules change. Similarly, you've gotten considerable interest rate risk exposure. A generation ago this strategy would have exposed you to several years of 10+% rates. In 1981, S&P500 return was -5.33% and the federal funds rate peaked at around 19%. The risks of this strategy can show up when you least want them to.

This might work long term for an UHNW investor taking small yearly loans. But for the rest of us, I wouldn't advise it as a long term strategy.

Sure. But again this was a made up example that shows that even with rapid increases in spending, you don't run into issues. Lets use normalish numbers. 3% SWR, 2% inflation, 7% return

year portfolio loan percent withdrawal
1 1000000 30000 3 30000
2 1080000 61200 5.666666667 30600
3 1166400 93636 8.027777778 31212
4 1259712 127344.96 10.1090535 31836.24
5 1360488.96 162364.824 11.93429927 32472.9648
6 1469328.077 198734.5446 13.52553917 33122.4241
7 1586874.323 236494.108 14.90314038 33784.87258
8 1713824.269 275684.5602 16.0859293 34460.57003
9 1850930.21 316348.0329 17.09129988 35149.78143
10 1999004.627 358527.7706 17.93531469 35852.77706
11 2158924.997 402268.1586 18.63279915 36569.8326
12 2331638.997 447614.751 19.19742943 37301.22925
13 2518170.117 494614.2999 19.64181437 38047.25384
14 2719623.726 543314.7848 19.97757188 38808.19891
15 2937193.624 593765.4434 20.21540012 39584.36289
16 3172169.114 646016.8024 20.36514382 40376.05015
17 3425942.643 700120.7096 20.43585613 41183.57115
18 3700018.055 756130.3664 20.43585613 42007.24258
19 3996019.499 814100.3611 20.3727825 42847.38743
20 4315701.059 874086.7035 20.25364342 43704.33518
21 4660957.144 936146.8595 20.08486306 44578.42188
22 5033833.715 1000339.787 19.87232482 45469.99032
23 5436540.413 1066725.973 19.62141163 46379.39012
24 5871463.646 1135367.47 19.33704335 47306.97793
25 6341180.737 1206327.937 19.02371163 48253.11748
26 6848475.196 1279672.676 18.68551231 49218.17983
27 7396353.212 1355468.673 18.32617553 50202.54343
28 7988061.469 1433784.64 17.94909373 51206.5943
29 8627106.386 1514691.059 17.55734764 52230.72619
30 9317274.897 1598260.221 17.15373045 53275.34071


Note how you don't get exploding debt. You hit a point where things end up hitting a bit over 20% and then it slowly declines. Now lets compare that to the person who is selling stuff. Assume a 25% tax what do the numbers look like

1 $1,000,000 $70,974 $0 $-40,365 $1,030,610
2 1,030,610 73,161 0 -41,179 1,062,591
3 1,062,591 75,445 0 -42,011 1,096,026
4 1,096,026 77,835 0 -42,859 1,131,002
5 1,131,002 80,335 0 -43,724 1,167,613
6 1,167,613 82,953 0 -44,606 1,205,960
7 1,205,960 85,696 0 -45,506 1,246,149
8 1,246,149 88,571 0 -46,425 1,288,295
9 1,288,295 91,587 0 -47,362 1,332,520
10 1,332,520 94,753 0 -48,318 1,378,955
11 1,378,955 98,078 0 -49,293 1,427,740
12 1,427,740 101,572 0 -50,288 1,479,023
13 1,479,023 105,246 0 -51,303 1,532,967
14 1,532,967 109,112 0 -52,339 1,589,740
15 1,589,740 113,182 0 -53,395 1,649,527
16 1,649,527 117,469 0 -54,473 1,712,523
17 1,712,523 121,987 0 -55,573 1,778,937
18 1,778,937 126,751 0 -56,694 1,848,994
19 1,848,994 131,779 0 -57,839 1,922,934
20 1,922,934 137,086 0 -59,006 2,001,014
21 2,001,014 142,691 0 -60,197 2,083,508
22 2,083,508 148,615 0 -61,412 2,170,711
23 2,170,711 154,879 0 -62,652 2,262,939
24 2,262,939 161,505 0 -63,916 2,360,527
25 2,360,527 168,517 0 -65,206 2,463,838
26 2,463,838 175,943 0 -66,522 2,573,258
27 2,573,258 183,809 0 -67,865 2,689,202
28 2,689,202 192,146 0 -69,235 2,812,113
29 2,812,113 200,986 0 -70,632 2,942,466
30 2,942,466 210,362 0 -72,058 3,080,770


The loan person has 9.3 million and owes 1.6 million. The person paying capital gains taxes has 2.9 million. That is a pretty fricken huge gap as a result of paying 600/yr in interest (which will grow) versus 10k of taxes. Obviously in the real world you end up with vastly different numbers with variable returns and rates. Now imagine that interest rates shoot up to 10% in year 15. The loan person could switch approaches, sell stock, pay LTGC and still come out ahead.

This isn't magic or risk free. The added leverage is going to pump up volatility. But for a certain class of people it is an interesting approach. I am not sure how I would sleep at night though with a scheme like this. But then again I am only a HNW guy and not a UHNW one.
Park
Posts: 735
Joined: Sat Nov 06, 2010 4:56 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

randomguy wrote: Lets use normalish numbers. 3% SWR, 2% inflation, 7% return

year portfolio loan percent withdrawal
1 1000000 30000 3 30000
2 1080000 61200 5.666666667 30600
3 1166400 93636 8.027777778 31212
4 1259712 127344.96 10.1090535 31836.24
5 1360488.96 162364.824 11.93429927 32472.9648
6 1469328.077 198734.5446 13.52553917 33122.4241
7 1586874.323 236494.108 14.90314038 33784.87258
8 1713824.269 275684.5602 16.0859293 34460.57003
9 1850930.21 316348.0329 17.09129988 35149.78143
10 1999004.627 358527.7706 17.93531469 35852.77706
11 2158924.997 402268.1586 18.63279915 36569.8326
12 2331638.997 447614.751 19.19742943 37301.22925
13 2518170.117 494614.2999 19.64181437 38047.25384
14 2719623.726 543314.7848 19.97757188 38808.19891
15 2937193.624 593765.4434 20.21540012 39584.36289
16 3172169.114 646016.8024 20.36514382 40376.05015
17 3425942.643 700120.7096 20.43585613 41183.57115
18 3700018.055 756130.3664 20.43585613 42007.24258
19 3996019.499 814100.3611 20.3727825 42847.38743
20 4315701.059 874086.7035 20.25364342 43704.33518
21 4660957.144 936146.8595 20.08486306 44578.42188
22 5033833.715 1000339.787 19.87232482 45469.99032
23 5436540.413 1066725.973 19.62141163 46379.39012
24 5871463.646 1135367.47 19.33704335 47306.97793
25 6341180.737 1206327.937 19.02371163 48253.11748
26 6848475.196 1279672.676 18.68551231 49218.17983
27 7396353.212 1355468.673 18.32617553 50202.54343
28 7988061.469 1433784.64 17.94909373 51206.5943
29 8627106.386 1514691.059 17.55734764 52230.72619
30 9317274.897 1598260.221 17.15373045 53275.34071
You're assuming a 2% interest rate and an 8% return. Based on historical returns, that 6% spread is unrealistic over a 30 year period. In the postwar era, stocks have beat T-bills by 6%. But that ignores the taxes and costs associated with stocks, and assumes that the interest rate is near the risk free rate. And you're assuming that desired income goes up only by the rate of inflation over a 30 year period. Such an increase in income would be acceptable for some, but not all.
Park
Posts: 735
Joined: Sat Nov 06, 2010 4:56 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

randomguy wrote:Now lets compare that to the person who is selling stuff. Assume a 25% tax what do the numbers look like

1 $1,000,000 $70,974 $0 $-40,365 $1,030,610
2 1,030,610 73,161 0 -41,179 1,062,591
3 1,062,591 75,445 0 -42,011 1,096,026
4 1,096,026 77,835 0 -42,859 1,131,002
5 1,131,002 80,335 0 -43,724 1,167,613
6 1,167,613 82,953 0 -44,606 1,205,960
7 1,205,960 85,696 0 -45,506 1,246,149
8 1,246,149 88,571 0 -46,425 1,288,295
9 1,288,295 91,587 0 -47,362 1,332,520
10 1,332,520 94,753 0 -48,318 1,378,955
11 1,378,955 98,078 0 -49,293 1,427,740
12 1,427,740 101,572 0 -50,288 1,479,023
13 1,479,023 105,246 0 -51,303 1,532,967
14 1,532,967 109,112 0 -52,339 1,589,740
15 1,589,740 113,182 0 -53,395 1,649,527
16 1,649,527 117,469 0 -54,473 1,712,523
17 1,712,523 121,987 0 -55,573 1,778,937
18 1,778,937 126,751 0 -56,694 1,848,994
19 1,848,994 131,779 0 -57,839 1,922,934
20 1,922,934 137,086 0 -59,006 2,001,014
21 2,001,014 142,691 0 -60,197 2,083,508
22 2,083,508 148,615 0 -61,412 2,170,711
23 2,170,711 154,879 0 -62,652 2,262,939
24 2,262,939 161,505 0 -63,916 2,360,527
25 2,360,527 168,517 0 -65,206 2,463,838
26 2,463,838 175,943 0 -66,522 2,573,258
27 2,573,258 183,809 0 -67,865 2,689,202
28 2,689,202 192,146 0 -69,235 2,812,113
29 2,812,113 200,986 0 -70,632 2,942,466
30 2,942,466 210,362 0 -72,058 3,080,770
It looks like the rate of return on stocks is about 7.1%. Also, you're assuming that the pretax SWR will be fully taxable at 25%. But some of that SWR will be considered return of capital and won't be taxed. I'll ignore the possible use of tax lots to defer tax. Finally, the person in the first scenario has paid no tax, and will have a higher cap gains tax bill than the individual in the second scenario.
Rotarman
Posts: 137
Joined: Tue Apr 05, 2016 5:14 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Rotarman »

Can someone explain how/whether this plan has any value outside the arbitrage of the interest on the loan vs the appreciation of the investments? If an UHNW takes loans and owed 20M at death and has a 40M portfolio is the estate not simply taxed on 20M of the assets it liquidates? The following is how I see the math roughly for a person who either does this or doesn't 1 year before death with no arbitrage. V is the value of estate, E yearly expenses, T tax rate, and I the interest on the loan = appreciation of investments
Case 1) (V-ET)I
Case 2) VI - ETI

Case 1 yearly expenses immediately liquidated and interest is earned on the remainder. Case 2 interest is earned on the full portfolio and also accrued on the cost of 1 years worth expenses and at death after year 1 investments are liquidated and taxes paid.
Tanelorn
Posts: 2151
Joined: Thu May 01, 2014 9:35 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Tanelorn »

Rotarman wrote:Can someone explain how/whether this plan has any value outside the arbitrage of the interest on the loan vs the appreciation of the investments? If an UHNW takes loans and owed 20M at death and has a 40M portfolio is the estate not simply taxed on 20M of the assets it liquidates?
I'm pretty sure the answer to the second question is "no". The estate gets the assets with a basis equal to FMV at the time of death, so no more capital gains if they are sold (up to luck from death to time sold), then the full proceeds pay off the debts, and the remainder goes to the heirs. I would welcome confirmation of this.
randomguy
Posts: 10592
Joined: Wed Sep 17, 2014 9:00 am

Re: How to Avoid Paying Taxes if You're UHNW

Post by randomguy »

Park wrote:
It looks like the rate of return on stocks is about 7.1%. Also, you're assuming that the pretax SWR will be fully taxable at 25%. But some of that SWR will be considered return of capital and won't be taxed. I'll ignore the possible use of tax lots to defer tax. Finally, the person in the first scenario has paid no tax, and will have a higher cap gains tax bill than the individual in the second scenario.
I will have to go back and double check the numbers sometime. Yes the taxes get more complicated. There is potentially cost basis but this scheme is for the people with low cost basis stock (i.e. you bought your shares for .01 when you started a company and sold those shares for 50 bucks). But there are also state taxes (i.e in CA you are pushing somewhere around 35%).

And sure the first guy is going to have a higher tax bill. But they also have a ton more money. Rate shifts (i.e. the increase from 15% to the current ~24%, all the past ones when we went from 28% to ending up with 15%) are the type of thing that add uncertainty.

It would be interesting to throw it into a monte carlo/historical simulator to see how things work out.
randomguy
Posts: 10592
Joined: Wed Sep 17, 2014 9:00 am

Re: How to Avoid Paying Taxes if You're UHNW

Post by randomguy »

Park wrote: You're assuming a 2% interest rate and an 8% return. Based on historical returns, that 6% spread is unrealistic over a 30 year period. In the postwar era, stocks have beat T-bills by 6%. But that ignores the taxes and costs associated with stocks, and assumes that the interest rate is near the risk free rate. And you're assuming that desired income goes up only by the rate of inflation over a 30 year period. Such an increase in income would be acceptable for some, but not all.
You can use whatever rate of increase in spending you want. But when you do your comparison make sure you use the same after tax spending for both portfolio. I expect you will find that rapid increase of the loan portfolio would rapidly deplete the person who tried to match it while paying taxes along the way.
Park
Posts: 735
Joined: Sat Nov 06, 2010 4:56 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Park »

randomguy wrote:the first guy is going to have a higher tax bill. But they also have a ton more money.
This strategy is about tax planning using tax deferral. Although I am more equivocal about its benefit, it is probably underutilized by Bogleheads overall. For myself, I see this as a useful way to manage the risk of bear market in stocks.
Rotarman
Posts: 137
Joined: Tue Apr 05, 2016 5:14 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Rotarman »

Tanelorn wrote:
Rotarman wrote:Can someone explain how/whether this plan has any value outside the arbitrage of the interest on the loan vs the appreciation of the investments? If an UHNW takes loans and owed 20M at death and has a 40M portfolio is the estate not simply taxed on 20M of the assets it liquidates?
I'm pretty sure the answer to the second question is "no". The estate gets the assets with a basis equal to FMV at the time of death, so no more capital gains if they are sold (up to luck from death to time sold), then the full proceeds pay off the debts, and the remainder goes to the heirs. I would welcome confirmation of this.
So I tried looking this up, and it's all pretty confusing. I think you're right about an immediate step up of the estate upon death for everything less than $5 million. Above that there's all kinds of rules which seem to imply no step up.

I can see this being useful for a non-UHNW individual who needs to tap taxable accounts with unrealized gain during retirement. If you were to instead take out a home equity loan for expenses you could perform a similar maneuver and avoid ever realizing those gains.
Tanelorn
Posts: 2151
Joined: Thu May 01, 2014 9:35 pm

Re: How to Avoid Paying Taxes if You're UHNW

Post by Tanelorn »

Rotarman wrote:So I tried looking this up, and it's all pretty confusing. I think you're right about an immediate step up of the estate upon death for everything less than $5 million. Above that there's all kinds of rules which seem to imply no step up.
I think you might be confusing income tax with estate tax - the step up in basis is regards to income tax, separate from estate tax. If you have an estate over $5M or so, I think you still pay nothing in income tax on the appreciated positions held when you died. However, you will have to pay estate tax at ~50% of the excess over $5M. Not sure how they handle netting out the estate's debts before or after assessing the estate tax. I guess if you've got more than $5M/person, you pay some fancy trusts lawyer and he tells you how not to pay it.
Rotarman
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Rotarman »

Tanelorn wrote:
Rotarman wrote:So I tried looking this up, and it's all pretty confusing. I think you're right about an immediate step up of the estate upon death for everything less than $5 million. Above that there's all kinds of rules which seem to imply no step up.
I think you might be confusing income tax with estate tax - the step up in basis is regards to income tax, separate from estate tax. If you have an estate over $5M or so, I think you still pay nothing in income tax on the appreciated positions held when you died. However, you will have to pay estate tax at ~50% of the excess over $5M. Not sure how they handle netting out the estate's debts before or after assessing the estate tax. I guess if you've got more than $5M/person, you pay some fancy trusts lawyer and he tells you how not to pay it.

My understanding is that the step up applies to the estate as well as the beneficiary. Ie the estate's basis is FMV at the date of death. So if the day before you die you drain taxable to pay off a million dollar loan your estate gets hit with capital gains tax whereas if your executor pays the loan the day after you die, there's no income tax involved. I'm still fuzzy on whether assets above 5 million that get charged estate tax have to worry about basis, but you're right that assets sold after death would only be assesed estate not income tax.
Honestly it's not a bad plan for a normal HNW individual either. Even pre-tax money in a retirement account could allow income tax to be entirely avoided this way as long as you have access to enough credit. I imagine the protections for retirement accounts make banks leery of giving out a loan with a 401k as collateral though.
Buffetologist
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Re: How to Avoid Paying Taxes if You're UHNW

Post by Buffetologist »

I like this idea in principle, but the problem is that if you are holding bonds, it makes no sense to borrow against your stocks because the loans have to go as a negative amount into your bond portfolio for your overall allocation. Even endowment funds generally go 60-40 stocks-bonds. Is this interest considered investment interest and thus deductible? If that's the case, I can see a little arbitrage opportunity between the after-tax rate on the loans and the pre-tax rate obtainable if the bond portion of a portfolio is in a tax-advantaged space. I'm currently doing that with my mortgage, where my after-tax interest on my 2.75% mortgage is 1.63%, but I can earn around 2% in Fidelity GNMA. Adding leverage to buy more stock increases your stock percentage.

Otherwise, the discussions presume a very heavily weighted stock portfolio.
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