Planning Your Financial Future
Timing is Everything with Estimated Tax Payments

Estimated tax payments four times per year can create stress and anxiety for many.

Timing is everything in life, and you don’t always have cash when you need it. As a law firm partner, cash distributions from your firm are inconsistent and may not coincide with large cash outflows in your personal life.

Before you dip into your investment portfolio, consider using margin on your non-retirement investment assets to make your tax payment and then pay it off immediately after your next distribution is made. Margin can make sense as a bridge loan to help fund tax payments or daily living expenses until the next partner distribution.

How does it work?

Margin accounts can be setup for almost all non-retirement investment accounts. Assets within the accounts act as collateral and the custodian (ex. Charles Schwab, Fidelity, Vanguard) will loan the owner money based on those assets. Different types of investments provide greater collateral, but a general rule of thumb is 40-50% of the account value can be borrowed. For example, an investment account that is worth $1,000,000 and is invested in a diversified portfolio of stocks and bonds will provide $400,000-$500,000 of borrowing capacity.

Below are a few highlights of margin accounts:

  • Zero cost to setup the account
  • Zero interest is charged if the account is never used (set one up just in case!)
  • Interest accrues daily and the balance can be paid off at any time
  • No pre-payment penalty

What’s the rate?

Each custodian or bank decides the rate they will charge their clients.  Often times the rate is variable so investors are susceptible to rising interest rates. This makes it perfect for short term bridge loans but not smart for long term financing like mortgages. Unlike some big brokerage firms, we do not receive any revenue from the margin interest our clients pay. Most big brokerage firms charge 6-8% on margin balances. We can not disclose our rate, but it is much lower.

Why margin?

Margin is great because it’s quick, easy, and CHEAP! We often see clients using a home equity line of credit to cover cash short falls but margin can be half the cost and offer greater capacity.

Margin is often associated with using leverage to enhance the gains (or losses!) of a portfolio. We don’t recommend that for clients due to the damage a significant market drop can have on the portfolio.

Is it tax deductible?  

We have seen big banks pitch the idea of margin being tax deductible for their clients. Yes, margin interest can be tax deductible IF it’s used for a taxable investment and the interest expense is greater than 2% of an individual’s adjusted gross income. Given the purpose we are recommending, the low cost to borrow, and the high income most partners earn, we rarely see partners deduct the margin interest. Please consult your tax advisor to discuss whether or not margin interest is deductible for you.

Know your options and make the decision that’s best for you

The income for law firm partners is not always predictable so it’s important to understand how to use your assets to fund short term cash needs. Margin is not for everyone, but a simple margin account can save you thousands of dollars in capital gains taxes or high interest debt.