A Sneaky Tax Strategy for Wealthy Old Investors

Hey everyone! Are you ready to file your taxes? The IRS starts accepting tax returns today! (January 23, 2023.) As for me, I am not ready at all. I’m still in Thailand and our tax file is a huge mess. I’ll deal with it when I get back home. However, I just learn about an excellent tax strategy for wealthy old investors. Most of us aren’t rich and old, but we all hope to be in that position someday. When you get there, this tax strategy might be a great benefit to you. 

Alright, just how wealthy are we talking about here? Let me explain the strategy and then work through a scenario.

SBLOC

The key to this tax strategy is the securities-based line of credit (SBLOC.) Basically, you can borrow money from your brokerage using your investment portfolio as collateral. When we retire, we plan to sell off some of our stock investment to generate income to fund our cost of living. However, once you are wealthy enough, using an SBLOC instead of selling your investment could generate significant tax savings. Someone named this the “buy, borrow, die” strategy. I guess that’s somewhat catchy.

Here are the reasons why this work.

  • Selling stocks is a taxable event. When you sell, you’ll pay 15% to 20% capital gain tax. If your cost basis is low, you’ll pay quite a bit of tax.
  • Getting an SBLOC and using the money isn’t a taxable event. You pay interest to the bank, but no tax. Your investment stays in your portfolio and you continue to benefit from the gains in the market.
  • The cost basis reset when you die. This is the other important part of the equation. You’ll have to set up an estate. The estate will sell part of your portfolio to pay off the SBLOC debt when you go. The estate won’t have to pay the capital gain tax. You’ll need to work with a good tax advisor to set up a trust.

Those are the main points. You avoid the long-term capital gain tax, but you’ll have to pay interest to the bank. However, it won’t make sense for everyone. When I learn about this tax minimization technique, I was a bit skeptical. Avoiding the capital gain tax is nice, but the interest will compound. This will only work for old rich people. The interest will eat up the portfolio if you live too long. Right?

Study cases

Let’s crunch some numbers.

Fred is 75 years old and he is in good health. His portfolio is worth $10 million. Most of the gains are taxable because he has been an investor for 60 years. Fred wants to sell $400,000 worth of investment to fund his cost of living. He’ll pay the 15% long-term capital gain tax and have about $340,000 to spend for the first year.

For the SBLOC option, he’ll have to borrow $340,000 and enough to pay the interest for the first year. From my research, the brokerages usually charge the prime interest rate. That’s about 7.5% right now. That’s higher than normal. In previous years, the prime rate was around 4-5%.

We’ll increase the cost of living to account for inflation each year. 

After crunching the numbers, the timeline isn’t a significant factor in the equation. That’s a surprise to me. The other numbers are much more important. Here are the variables we need.

  1. The prime interest rate. This is how much interest you’ll pay on the loans.
  2. The portfolio gains rate. This is how much your portfolio will grow each year.
  3. Inflation.

Here are some charts.

Scenario 1: low interest rate, good portfolio gains

The first one is the ideal scenario. The interest rate is 4% and the portfolio gains 8% annually. Using the SBLOC will give Fred an extra $2,000,000 after 10 years. I set inflation to 3% here.

Scenario 2: High interest rate, stagnate portfolio

Next, let’s see a more difficult scenario. I set the interest rate to 7.5%. That’s what the prime rate was in December 2022. Fred became very conservative and his portfolio gains just 1% annually. The inflation is set at 7%. In this tough scenario, Fred lost $1,500,000 from using the SBLOC.

Scenario 3: portfolio gains = prime rate

In the last scenario, I set the interest rate to be the same as the portfolio gains. The SBLOC method came out ahead by about $700,000.

Conclusion

From messing around with the parameters, I found that inflation and the timeline don’t really matter that much.

To make this strategy work, Fred’s portfolio must outperform the prime rate. This is the most important point. Fred’s $10,000,000 portfolio stays intact and the gains outpace the interest he has to pay.

This shouldn’t be too difficult to pull off. The stock market usually outperforms the prime rate significantly. However, some years can be very bad as well. In 2022, the S&P 500 lost nearly 20% and the prime rate was higher than usual. However, it seems the SBLOC strategy would win in the long haul. The stock market has many more good years than bad years.

The other issue is Fred is paying the big bank to make this work. Instead of helping the country by paying taxes, he’s enriching himself and other wealthy people. That doesn’t seem right.

Alright, I hope to be old and rich someday, but I’m not sure if I’ll use this strategy. You’ll probably come out ahead, but there are risks too. Also, I don’t really like paying a huge amount of interest to the big bank. I’d rather pay tax. But who knows? I might change my mind when I’m really rich…

What do you think? Is this a good tax strategy?

*Passive income is the key to early retirement. These days, I’m investing in commercial properties with CrowdStreet. They have many projects across the United States. It’s been working so well that I’m planning to sell our rental condo so I can invest more. Go check them out!

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Image credit: Izzy Park

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Joe started Retire by 40 in 2010 to figure out how to retire early. After 16 years of investing and saving, he achieved financial independence and retired at 38.

Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!

Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.
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17 thoughts on “A Sneaky Tax Strategy for Wealthy Old Investors”

  1. I’ve heard about this strategy recently but didn’t know what it was called. Your post makes it easier to see why it’s so good and where it could possibly break down.

    This is such a fascinating concept but it makes sense. I’m going to dig into this one a little further since we’re currently living off our portfolio now by selling assets. I might need to run this by a financial advisor/CPA.

    Thanks for the cool post, Joe!

    Reply
  2. Seriously? It’s sickening to see how wealthy people can game the system to avoid taxes. This is something Congress should shut down.

    Reply
  3. Well I had no idea this was even a thing. I think the closest we have in Australia might be the ‘reverse mortgages’ where you basically draw out of a HELOC and when you die the bank gets the mortgage paid out from the sale of estate assets. Buy borrow die, sounds legit haha

    Reply
  4. This is a well known concept and how the rich avoid taxes so great you are introducing it to everyone. I don’t understand the scenario when this strategy would NOT work. Even at high inflation and low returns for a decade, assuming you have any capital gains, it should always be better to take out a SBLOC since you are not comparing the interest paid to the returns, but compared to capital gains of 15 or 20%. I guess the only way it wouldn’t work is if you did tax gain harvesting along the way.

    Reply
    • The only time it won’t work is if your portfolio goes down. Then, interest would be a big factor. But bear markets don’t last that long so our portfolio should be able to recover in subsequent years.

      Reply
  5. Capital gains can cost you more than 15%. If your taxed income is over ~500K your capital gains rate is 20%. If your total taxed income is over 250K you’ll owe another 3.8% on Net Income Investment Tax for any capital gains over the 250K. The NIIT isn’t indexed for inflation so it will apply to more and more people over time.

    And then there is the possibility of state tax. In California capital gains are taxed the same as other income. That could easily be 9% or more if you’re “high income”.

    Reply
  6. i noticed lots of high income/rich folks like to use debt rather than sell investments. a family friend wanted to raise a couple of hundred grand for some large expenses and his advisor had him take a HELOC. he thankfully locked in the loan middle of last year before the borrowing rates went crazy.

    me? i’m debt averse and would rather find anther way. plus we have the advantage of fully funded roth ira’s for the past 20 years.

    Reply
  7. I’ve been meaning to look into this strategy. I have a couple of questions though:

    1. Do you need to be old? There’s no particular age that this becomes available, right? I’ve read that rich celebrities do this and aren’t super, super old.

    2. What’s the minimum amount that you’d need to start one? I did a quick Google search and it seems like it is $100,000 (according to the SEC). Practically, maybe banks only bother if it’s a big enough account for them? Or maybe there’s too much overhead with the estate set-up to make it worthwhile on a small scale?

    Reply
    • 1. No, you don’t need to be old. That part is useful for resetting the cost basis. If you have a big portfolio, you can borrow 2%. That should last for a very long time.
      2. I don’t know. $100,000 sounds about right. JPM and Wells Fargo support these, but you have to invest with them.

      Reply
  8. Wouldn’t this trigger any kind of margin call if the market crashes, just like in the case of a regular margin loan? If that’s the case, wouldn’t the brokerage just start selling your stocks and you may have to end up paying a capital gain tax? Sounds risky.

    *BoycottTwitter
    *BoycottTesla

    Reply
  9. Interesting strategy Joe and I appreciate you sharing the concept. Taxes are an important consideration in personal finance.

    We will likely not ever be that wealthy but even if we were I think this sounds like an awful lot of financial gymnastics for not enough promised return on my efforts. I am gonna place this in my “interesting but too hard” pile of finance knowledge. 🙂

    Reply
  10. I’ve had had access to a SBLOC for a decade now. I use it for short term loans but the variable interest rate that adjusts with Prime is too risky. Instead I cash out refi all my properties with max leverage to access cash instead of selling stocks or real estate. The interest rate is fixed from 5 to 30 years and the interest is deductible. I typically reinvest the proceeds but one day I might use it for living expenses.

    Pro tip: If you want max leverage and low interest rates you’d best refinance before you quit your day jobs. Don’t wait until after retirement. Just before I was laid off in 2013, I bought an investment property and opened a HELOC just before being laid off. I had 3 months notice so I could plan everything. I know many people try to reduce debt if being laid off but I wanted to maximize leverage and credit while the banks were still lending.

    Reply

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