Establish a PAL now, for future use -- or wait until needed?

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lairdb
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Joined: Mon Nov 04, 2013 11:16 am

Establish a PAL now, for future use -- or wait until needed?

Post by lairdb »

I've been reviewing the discussion of using pledged asset lines at low rates to manage capital gains timing, and I'm fairly clear on the risk of call, etc.

Here's today's question: right now, I'm still a W-2 employee, and probably won't use this technique until I'm not. Should I establish a PAL now -- or just wait until that time comes?

(Primary holdings are at ML, and some at Fido -- about 80% in taxable, thus the sensitivity to CG particularly.)

I don't really need the line now, but you know the saying about the best time to get a loan is when you don't need it. (Or, is there prep work, e.g. open and lightly fund an IB or M1 account just to establish history for a future line, or to get a future rate match?)
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FiveK
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by FiveK »

Oh, not a Permissive Action Link (PAL)?

In any case, don't know enough about either to comment....
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ResearchMed
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by ResearchMed »

FiveK wrote: Wed Jul 21, 2021 11:30 pm Oh, not a Permissive Action Link (PAL)?

In any case, don't know enough about either to comment....
:shock:

Hopefully for *future* use :!:

RM
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tcw
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by tcw »

I recently opened a PAL at Schwab, without having an immediate use for it. As far as I can tell, there's no reason not to open up a PAL before you need it. I'm thinking of using it as an emergency fund -- instead of keeping X months of funds in cash, I have the option of keeping that money invested in stocks and taking a loan from the PAL if I need the cash.

For example, if I need cash and the market has recently had a big drop, then, instead of being forced to liquidate stocks at a low point, I can take a loan and wait for the the stocks to recover, then sell the stocks to pay back the loan. (I probably would never exceed 10% of my loan limit, so that I'm very, very safe from a margin call.) On the other hand, if the stocks have been doing well, then I can just sell stock and not use the PAL.

Of course, the danger with this kind of thinking is that you might convince yourself that it's always better to take a loan from the PAL and not pay it back, because the expected returns on investments will be higher than the interest on the PAL (assuming you have a good interest rate on the PAL, which may require negotiating with your broker). And that wouldn't be very Bogleheadish.
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lairdb
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by lairdb »

tcw wrote: Thu Jul 22, 2021 8:50 pm I recently opened a PAL at Schwab, without having an immediate use for it. As far as I can tell, there's no reason not to open up a PAL before you need it.

[...] (assuming you have a good interest rate on the PAL, which may require negotiating with your broker).
Thanks. Curious -- did you negotiate rate at all, or did you accept the published rates?
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batpot
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by batpot »

From the Schwab website:
Minimum line amount:$100,000

Initial minimum loan amount: The first loan made under the PAL must be equal to or greater than the initial minimum loan amount, which is currently $70,000.

Interest rates are based on an Index, as determined by Schwab Bank from time to time, plus an Interest Rate Spread. The interest rate will increase or decrease as the Index changes, or if Demand is made on the PAL and Schwab Bank applies a post-Demand spread. The Interest Rate Spread is determined based on the Loan Value of Collateral (as defined in the PAL Agreement) at the time the PAL is opened. Note that changes in the interest rate may cause your monthly payments to change. If interest rates rise, your borrowing costs can increase. In addition, Schwab Bank reserves the right to change any part of the interest rate after the PAL is established, including the Index, Interest Rate Spread, or post-Demand spread, upon further notice
So it's basically a HELOC, but backed by your 401k instead of your house?

What kind of interest rates can you get? Are they always tied to an index, or can they be fixed?
Topic Author
lairdb
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by lairdb »

batpot wrote: Fri Jul 23, 2021 3:32 pm So it's basically a HELOC, but backed by your 401k instead of your house?

What kind of interest rates can you get? Are they always tied to an index, or can they be fixed?
Right-ish -- I'm not sure anyone will loan against retirement accounts, but they will against conventional holdings. Search around -- lots of discussion about paying a little interest on these to avoid exiting positions you'd rather hold onto.

IBKR is often mentioned rates from index+1.5% down to index+0.3% (for very large loans) -- though frequent mentions that they will liquidate without notice to cover. (https://www.interactivebrokers.com/en/index.php?f=46376)
M1 lists "2% based on FFR" so I'm guessing that FFR+1.95%. (https://www.m1finance.com/how-it-works/borrow/)

Merrill (https://www.ml.com/solutions/lma-account.html)
Schwab (https://www.schwab.com/pledged-asset-line)
Fidelity (https://www.fidelity.com/trading/margin ... -borrowing)

Some stories here and there about people using IB or M1 rates to negotiate at their existing broker.

Always, AFAIK, indexed (actually, Fidelity is a bit of an exception -- they have a Base Rate that they manage, rather than explicitly indexed).
jarjarM
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by jarjarM »

batpot wrote: Fri Jul 23, 2021 3:32 pm From the Schwab website:
Minimum line amount:$100,000

Initial minimum loan amount: The first loan made under the PAL must be equal to or greater than the initial minimum loan amount, which is currently $70,000.

Interest rates are based on an Index, as determined by Schwab Bank from time to time, plus an Interest Rate Spread. The interest rate will increase or decrease as the Index changes, or if Demand is made on the PAL and Schwab Bank applies a post-Demand spread. The Interest Rate Spread is determined based on the Loan Value of Collateral (as defined in the PAL Agreement) at the time the PAL is opened. Note that changes in the interest rate may cause your monthly payments to change. If interest rates rise, your borrowing costs can increase. In addition, Schwab Bank reserves the right to change any part of the interest rate after the PAL is established, including the Index, Interest Rate Spread, or post-Demand spread, upon further notice
So it's basically a HELOC, but backed by your 401k instead of your house?

What kind of interest rates can you get? Are they always tied to an index, or can they be fixed?
Generally one cannot use retirement account like 401K or IRAs as collateral. Most are tied to an index but it can be negotiated to be fixed (depending on account size/customer relationship and etc).
jarjarM
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by jarjarM »

Since most PAL has no maintenance fee or opening fee, I would just open one now. I don't see the harm in it. I'm planning on doing that soon in case DW falls in love a second home :oops:
tcw
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Re: Establish a PAL now, for future use -- or wait until needed?

Post by tcw »

lairdb wrote: Fri Jul 23, 2021 11:03 am Thanks. Curious -- did you negotiate rate at all, or did you accept the published rates?
I negotiated a rate of SOFR+2.30%, and SOFR is currently 0.05%. With the assets I have at Schwab, at their published rates I would have gotten SOFR+3.40%. To negotiate, I used Interactive Broker's rates as a point of comparison. IB still has notably lower rates, but the rate I have at Schwab is good enough for me.

Some things I learned: at Schwab, the brokerage account that's used as collateral for the PAL is a cash account, not margin account. I don't trade on margin so losing that doesn't bother me, but it also means that if you trade frequently in that account, you have to be careful about settlement date violations, like Good faith and Freeriding violations.

Also, Schwab keeps track of the "loan value of collateral" for each type of security in the account. For most stocks and ETFs, the loan value of collateral is 70% of their market value. However, some stocks have lower loan value of collateral. I have some stocks whose loan value is 30% or 60%. And some have 0 loan value. For example, I have some leveraged ETFs, which have no loan value in the PAL collateral account.

For these reasons, I decided to keep my stable investments in the PAL collateral account, but I moved some other investments (like the leveraged ETFs) into a normal brokerage account with margin. That way, I can do a bit of fun trading and not have to worry about settlement date violations, and it doesn't affect how much I can borrow from the PAL, since the leveraged ETFs have no collateral value there.
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