How to make a margin account work for you

WASHINGTON — Even the wealthiest of clients can sometimes find themselves cash poor. In times of a cash crunch, often the first thought is to find a bank to loan you money. In some circumstances, that solution may be appropriate.

For cases where there are credit issues, cash needs that aren’t financeable, or a high bank loan interest rate, where do high net-worth clients turn for liquidity?

A margin account may be the answer.

Traditional margin accounts are basically lines of credit secured by non-retirement brokerage accounts. If you hold cash and securities in a taxable brokerage account, your broker can extend credit to you.

If you work with a financial adviser, you can also ask them to help you with this. Margin interest rates are typically based on a benchmark interest rate that adjusts.

In addition to providing immediate liquidity, some of the advantages of margin include: lower interest rates versus conventional bank loan rates, avoiding capital gains tax on asset liquidations, interest-only monthly payments, drawing cash over time rather than all at once, and lack of a prepayment penalty on principal reductions.

Some unique ways high-net-worth investors have effectively used margin include:

Funding a business venture: Whether a business owner is funding a startup venture or an existing enterprise, margin loans are often used to support needs that cannot be financed by the bank.

Real estate investors as well as small business owners can use their private wealth to fund company needs and, in some cases, business cash flow is used to cover margin interest costs or to repay the principal balance over time as the business generates cash flow.

Purchasing a second home: Margin can be a low-cost way to provide liquidity for a variety of real estate transactions. For example, margin can be used to finance construction if a construction loan is either unobtainable or too expensive. We’ve also helped clients get margin loans on a temporary basis to bridge the gap between when a new home is purchased and an existing home is sold.

Especially in high-end homes, you may end up doubling your mortgage payments if your existing home sale is stalled. Or, you may close on a new purchase sooner than expected, causing a temporary need for a substantial amount of cash.

Funding long-term care expenses: We have employed margin for a client that needed help paying for assisted living expenses for an elderly father. In cases where elderly relatives may be running out of money, utilizing margin on their account may be preferable to selling low tax basis investments. This is especially true at the end of life where high health care expenses often require a substantial amount of cash.

One option in this circumstance is to sell the elderly relative’s securities, but doing so generally creates a capital-gains tax liability which can be costly. Alternatively, if the securities account is margined, then at death, the tax basis on the underlying securities may be stepped up, which may reduce or perhaps eliminate that capital gains tax.

For those who may be shouldering costs for a parent or other relative, their own accounts can be margined, saving them taxes and allowing their personal portfolio to stay diversified and invested for their own longer term needs.

As with most financial decisions, there are some risks to be considered, and we recommend seeking the advice of a financial professional before making a decision to employ margin.

First, not all securities are marginable. That’s because, as a result of previous financial crises, securities regulation recognizes the risk margin may pose to investors. Therefore, margin is legally allowed only on securities that have a minimum level of liquidity. That means investments such as private equity deals, hedge funds, and certain other alternative assets are not available to secure margin credit.

Equities and mutual funds that do qualify for margin are generally limited to margin of 50 percent of the value, whereas bond investments may qualify for margin of 75 percent of value. Perhaps the most important thing to consider is that securities markets are volatile. So, we often recommend clients only margin accounts up to about 80 percent of the total statutory limits. That helps reduce the potential for a “margin call” which requires the investor to provide immediate cash if the value of the underlying assets falls below legal limits.

Whether your cash need is temporary or of a longer-term nature, if you have invested assets, consult with your adviser about the potential for margin. Some firms negotiate borrowing rates that can reduce your borrowing costs. Used with prudence and caution, margin can be a powerful tool to address a multitude of cash needs for those with invested wealth.

Dawn Doebler, a senior wealth adviser at Bridgewater Wealth and co-founder of Her Wealth™.

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