Consider a Pledged Asset Line
Many retirees consider the benefits of downsizing their home at some point. According to Zillow, 46% of Baby Boomers who sold their homes in 2017 were in the process of downsizing. But what happens if you find your ideal retirement home, whether that be a community that requires an entry fee or a smaller, more manageable space in a warmer climate or a friendlier tax jurisdiction before selling your primary residence? To the extent you have after-tax portfolio assets, a pledged asset line may be a good short term solution.
What is a Pledged Asset Line?
Similar to a home equity line of credit, a pledged asset line can provide liquidity at a relatively low interest rate. Instead of using the home as collateral, however, retirees can use portfolio assets that they have accumulated in after-tax accounts. This would include individual accounts, joint accounts and certain types of trust. Retirement account, such as IRAs, ROTH IRAs or 401k’s are typically not eligible to be used as a collateral for a pledged asset line. Pledged asset lines, similar to margin loans, allow investors to leverage their portfolios to provide liquidity, while maintaining ownership of investments in the pledged account. Unlike margin loans, pledged asset lines cannot be used for the purchase of more securities. This typically means that the interest payments are also not tax deductible.
What are the benefits?
Let’s assume that a retired couple has a portfolio worth $4 million. They have $2 million in pre-tax IRAs and $2 million in a joint account. We can also assume the cost basis of that joint account is $1 million, so there is an unrealized gain of $1 million if they were to liquidate that joint account. Let’s finally assume they have a home worth $1.2 million.
They have identified a continuing care retirement community where they would like to spend the remainder of their retirement. The entry fee for a spacious 2-bedroom unit with a den is $700,000. These units rarely become available, but one has just opened up, and they need to make a decision within 30 days… too short a timeframe to list and sell their home.
If they were to raise the cash in their joint account, they would most likely be looking at capital gains tax of over $50,000 (assuming a 15% long term capital gains rate on the sale of assets.) It could be higher if their taxable income pushed them into the 20% capital gains rate threshold, if they were subject to additional Medicare-surtax on investment income, and if capital gains are taxed at the state level. Drawing from the IRAs would not help, since IRA distributions are taxed at even higher ordinary income rates.
By using the pledged asset line against the $2 million joint account, they would not need to sell investment assets, but rather use them as collateral for the $700,000 loan. While outstanding, the loan would be subject to monthly interest payments, but principal from the sale of their primary residence in the future could pay off the line completely. Also while the loan is outstanding, dividends and interest generated in their portfolio can be used to offset monthly interest payments.
What’s the downside?
While pledged asset lines provide a lot of convenience for tax planning, they don’t work well for retirees with only pre-tax retirement accounts. Additionally, the bank providing the line will typically need to approve any withdrawals or transfers from the account, which may create some inconvenience for cash flow planning. Additionally, like margin loans, a pledged asset line may be subject to a margin call if the value of the investments decline in value.
Do you have an opportunity on a retirement home that may require immediate liquidity? Do you have concerns about the tax impact of raising cash or the timing of the sale of your existing home? If so, a pledged asset line may be a good solution. Give us a call to discuss further!
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.
This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.