Travis Russell

Travis Russell, CFP®

Travis employs many of the disciplines of success that he learned as a Division 1 hockey player – namely, persistence, practice, and a having passion for what you do – to his role as Principal and Client Advisor.

Quarterly estimated tax payments or other large expenses can create cash flow challenges in situations where a client doesn’t have cash on hand because income distributions from their small business or employer are inconsistent.  These large cash outflows such as tax payments, home improvements, college tuition or other major expenses may not coincide with their cash flow and it’s necessary to look for an alternative cash source.

However before thinking about dipping into an investment portfolio, consider temporarily using a margin loan on non-retirement investment assets to make those large payments and then pay the loan off immediately after the next big paycheck comes in. Margin loans can make sense as a bridge to help fund tax payments or other expenses until your next big income receipt.

However, it’s important to use margin and margin loans responsibly.

How do margin accounts and margin loans work?

Margin accounts can be setup for most non-retirement investment accounts. Account assets within 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 worth $1,000,000 and invested in a diversified portfolio of stocks and bonds could 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 rate will I be charged on my margin loan?

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

Why use a margin loan?

Margin is great because it’s quick, easy, and can be 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.

Another big advantage is that you can avoid selling assets in your portfolio to fund your cash needs, thereby avoiding the potential for capital gains taxes.

Margin is often associated with using leverage to enhance the gains (or losses!) of a portfolio. We typically don’t recommend this for clients due to the damage a significant market drop can have on the portfolio.  However, that doesn’t mean margin is inappropriate to help with cash flow timing issues.

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 you itemize your other tax deductions. There are other limitations as well. Given the purpose we are recommending, the low cost to borrow, and the high income many clients, we rarely see clients 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

Your income may not always be 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.

Want to learn more about how we help our clients balance their financial goals and obligations?