A vintage Ferrari? Rich investors use ‘The Bank of Me’ to splurge without paying capital gains tax

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Affluent investors seeking to splurge on a vacation home or vintage Ferrari GTO are increasingly tapping into a cut-rate source of financing: The Bank of Me.

Ultra-wealthy people have long leveraged hefty paper profits in their investment portfolios into bargain loans that provide immediate cash. Now ordinary rich investors flush with gains during the COVID-19 pandemic are doing the same, bankrolling pricey purchases and paying off major obligations.

Securities-based loans can give investors both sides of the trade. Borrowers don’t sell their stocks or bonds, so their retirement portfolios preserve the same room to grow as before. They get cash reflecting the profits their investments have reaped, just as the pandemic economy lifts and pent-up demand surges. Best of all, the loans give borrowers access to the fruits of their wealth without having to pay capital gains taxes (now 23.8%, including the Obamacare surcharge, and set to nearly double under a proposal by President Joe Biden).

A regular securities-based loan, which can’t be used to buy stock, is sometimes called a pledged asset line. When used to buy stock, it’s called a margin loan. Both loan types have soared in recent months. Individual consumers (along with broker-dealers that lend out securities for their own accounts) had nearly $882 billion in the loans in June 2021, up nearly 51% from nearly $585 billion a year ago, according to self-regulator FINRA. The watchdog doesn’t break out the percentages for types of borrowers.

Investors flush with paper profits are morphing them into tax-free cash.

Financial Planning

You are effectively the bank
Tom MacCowatt, a partner and CFA at Williams Jones Wealth in Palm Beach, Florida, says that people taking the loans “are borrowing to fund a house purchase.” He cites married clients who recently borrowed around $2 million to purchase a vacation home in Colorado.

“Rather than going to JPMorgan and getting a mortgage of 3% or 4%, they can borrow against their own portfolio and get a lower rate,” he says.

His clients also saved on taxes. Had they cashed the $2 million out of their account to fund their purchase, they would have owed $476,000 in capital gains levies ($868,000 under Biden’s proposals, not including any state tax). They would have also lost out on future gains on that money. Assuming a conservative 6% annual rate of return, the $2 million would be worth more than $6.4 million after 20 years, according to investor.gov‘s compound interest calculator.

Tax laws prohibit using IRAs and their Roth cousins as collateral for a cash loan (many 401(k) plans allow loans). So what’s called the “borrow, buy and die” approach to estate planning typically takes place against a brokerage account.

Wall Street banks and brokerages like securities-based lending because it directly boosts their bottom lines. Clients don’t sell their holdings, so the banks continue to earn fees on their total assets under management, as well as an additional fee for the loans. JP Morgan Chase reported a 27% increase in lending- and deposit-related fees, to $633 million, in the second quarter of 2021 compared to a year ago. Bank of America, which includes Merrill Lynch and the private bank, did more than $46 billion in securities-based loans $47 billion in securities-based loans last quarter, up more than one quarter from a year ago.

Big banks aim securities-based loans at wealthy investors, including retired boomers who have solid investment portfolios but no income because they’re no longer working.

The “borrow, buy, die” strategy can bankroll luxury purchases without the tax hit.

Bloomberg News

“There’s been a spike in interest especially in the last year,” says Andy Kapyrin, a CFA and co-head of investments at independent advisory firm Regent Atlantic. “Many investors with large portfolios have a hard time taking out a mortgage because they are retired and don’t have earned income anymore — mortgage standards are very tight.”

A 1963 Ferrari GTO
Clients of brokerages can go straight to their aggressively marketed programs. “The restaurant you’ve always wanted to open. That advanced degree you finally have time for. The perfect house that won’t be on the market long. A 1963 Ferrari GTO, just because,” Morgan Stanley’s website says. A “special, limited-time offer” from the bank in an undated “spring lending 2021 flyer” advertised rates as low as 1.5% for a one-year securities-based loan, and 2.45% for a seven-year loan. Any amount not repaid within the time limit bears a much higher variable rate. Wells Fargo lets clients borrow against up to 95% of their pledged assets and says common uses include house purchases and renovations, taxes, businesses, boats, cars and other luxury purchases. TD Ameritrade includes “memorable life events” as one purpose of the loans.

Investors eye a line of vintage Ferrari GTOs, which can be acquired through a securities-based loan.

Bloomberg News

Brokerages that provide custody and clearing services to independent advisors are also leaning on those with high net worth clients.

“We’re finding that clients are using securities-based loans a bit more in the current environment than they had previously,” says Daniel Duca, a CFP and associate director at Altfest Personal Wealth Management in New York.

He cites a retired couple who borrowed around $500,000 at 2% interest from a $1 million line of credit backed by their portfolio. He says they used it to buy a house, something that would have been more expensive and difficult through a mortgage lender, given that they’re retired and have less income.

“We’ve secured loans well below 2% for clients recently,” Duca says — far less than rates for mortgages, home equity lines of credit and traditional margin loans.

The process is quick, perhaps several days, and painless — not a lot of bureaucratic paperwork.

“This is often a lower interest cost than other forms of borrowing like personal loans or HELOCs,” Kapyrin says.

What could go wrong?

If markets decline, borrowers face the risk of a margin call, a nasty situation in which a lender immediately demands either more securities or repayment of the loan, and losses can be magnified. Both FINRA, the self-regulator overseeing brokers, their Wall Street employers and independent advisors, and the SEC flagged the risk of “securities-backed lines of credit” in 2015. Despite the recent surge in the loans, they haven’t weighed in heavily since, though the SEC recently cautioned again about margin loans.

Securities Litigation & Consulting Group, in McLean, Virginia, says that “securities-based lending presents some of the most serious conflicts of interest in the broker/client relationship. It puts brokers and RIAs, who are supposed to be investment professionals, in the position of recommending an action that often is detrimental to their clients’ long-term goals of wealth preservation and capital growth.”

Meanwhile, investors are partying. Schwab touts the loans as good for things including a “dream vacation.”