Buy, Borrow, Die: Not Best for Everyone
With interest rates near historic lows and the market near all-time highs, there are more people borrowing against their portfolios than ever before. Using debt wisely to increase wealth and reduce taxes is not a new concept; however, recently, there has been a spotlight shined on the concept from Wall Street Journal’s article “Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth” to ProPublica’s article focusing on billionaires’ use of loans to fund their lifestyle drastically reducing their taxes.
Both articles point to a strategy that takes advantage of two key aspects of the tax code:
- Unrealized Gains are only taxed when sold –If you hold investments in a taxable account and those investments have increased in value, you control when and how much you are taxed.
- Step up in Basis at death – when you pass away, any appreciation in a taxable account is forgiven. For example, if your account value grew from $1 to $100 and you pass that account onto your heirs at your death, the $99 is forgiven (basis is stepped up).
Understanding these tax provisions is and has been foundational to the planning we do for all our clients.
Our trading strategy is built to create “Tax alpha” which is a fancy term for minimizing taxes by managing the portfolio at the individual lot level while looking for opportunities to tax loss harvest and sell strategically. That trading strategy is then tailored to your personal situation – tax rate now vs. in the future, cash flow needs, types of accounts you own and how much to take from each – all to minimize your taxes today, in the future, and for your heirs.
Portfolio debt fits into that equation as well, albeit for short-term planning needs. If you have a taxable portfolio, you likely have the option to take out a loan against your investments. Currently, the rate is very attractive due to the low interest rate environment coupled with one of the benefits of working with BDF is that we have a further discounted rate for all our clients.
Using a Portfolio Loan
So why and when should you think about using this? The short answer is anytime you have a cash need that can be paid back within a year and would cause taxable gains to raise the cash. For example, a home purchase and sale where the closing dates don’t line up perfectly. A portfolio loan can be used as a short-term bridge to bring a cash offer, close on a purchase while waiting for your sale proceeds to come in and pay off the debt. This avoids selling any investments at a gain and therefore avoids tax as well. It could also be used as a bridge to push taxable income into a different tax year where the tax rate is lower.
The focus of the ProPublica article was billionaires borrow against their wealth as a long-term strategy which brings on a lot more risk and could be cost-ineffective. Specifically…
- Leverage comes with risk – with portfolio loans, there is a certain amount of collateral required (generally 2x the loan value). If the market falls, your investments fall. Therefore, the collateral is reduced, resulting in either forced selling of securities at depressed market prices or money that must be deposited to satisfy the loan.
- Rates are variable – we are in a low-rate environment now, but as the economy recovers, rates will rise and the cost of the loan increases.
- Tax Law Changes – one current proposal by the Biden Administration is removal of the step-up in cost basis, which would cripple the “Buy, Borrow, Die” strategy.
- It may be obvious, but billionaires have more margin for error to absorb all these risks and often have concentrated wealth in one stock or companies where gains are disproportionately high.
Tax mitigation and optimizing the use of debt are keys to a well thought out financial plan. If you have questions on how this applies to your specific financial situation, please do not hesitate to reach out to your team.
No representation is being made that any strategy shown will or is likely to achieve results similar to those shown in this presentation. BDF does not provide legal, tax, insurance, social security, or accounting advice. Clients of BDF should obtain their own independent tax, insurance, and legal advice based on their particular circumstances. The information herein is provided solely to educate on a variety of topics, including wealth planning, tax considerations, insurance, estate, gift, and philanthropic planning.
Neil heads BDF’s Financial Planning Committee whose goal is to ensure BDF provides a best in class, proactive, and engaging financial planning experience for clients. His passion is helping executives, widows and retirees live their full lives while navigating their wealth planning complexities. Neil has his Masters in Financial planning and has frequently been named to both Forbes and Chicago Crain’s list of Top Wealth Advisors.