Many high-net-worth individuals have a significant portion of their wealth stored in financial assets – e.g. stocks and bonds in a portfolio. With the success of the markets over the last decade, many investors have greatly benefited from an increase in the value of these assets. While you may be happy to allow these investments to continue to grow in the market, situations can arise where you need to access this wealth to pay for other expenses. Some common examples of this are:
- Business Liquidity: you own a business and need cash to cover expenses or invest in an expansion project.
- Estate Liquidity: you need cash to pay expenses while estate assets are tied up in administration.
To access liquidity, you could sell investments to generate cash. However, there a couple of disadvantages to making this decision. First, if the securities have an embedded capital gain you will generate taxes on a sale. Second, taking your investments out of the market increases the risk of opportunity cost because you can miss out on future returns.
A line of credit can be a great solution to circumvent these problems. Most people are familiar with the concept of a Home Equity Line of Credit (HELOC). This product allows you to access the equity in a real estate property without having to sell the asset. A Securities-Backed Line of Credit (SBLOC) is a similar lending product that allows you to access the value of your investment portfolio without selling the securities. A SBLOC is a revolving line of credit that is collateralized by the value of securities in a brokerage account. SBLOCs are only available in after-tax investment accounts. They can be a very attractive source of liquidity for a few reasons:
- The application and approval process is quick.
- The interest rates are often lower than other common forms of credit.
- The loan is perpetual. There is no term or maturity date.
Let’s look at a hypothetical example to see how an SBLOC would work:
A couple that lived in the suburbs for their entire careers are planning to move to a beach home in retirement. About 2 years prior to their projected retirement date, they find the perfect home for sale right on the water. They don’t want to let the opportunity slip away. The purchase price of the beach home is $1,000,000. The estimated market value of their current home is also $1,000,000. They have a diversified investment portfolio worth $2,000,000 with a cost basis of $500,000. They could sell securities and generate cash to buy the beach home, but that would trigger a large tax bill. Instead, they decide to open a SBLOC at their custodian which allows them to borrow $1,000,000 of cash tax-free using their $2,000,000 portfolio as collateral. They purchase the beach home and are required to make monthly interest payments on the loan balance. 2 years later, they retire and sell their house in the suburbs. They use the sale proceeds to pay off the SBLOC and close out the line of credit.
There are a couple of things to keep in mind about SBLOCs that can be disadvantages:
- The securities must be moved to a new pledged account and the borrower cannot transfer the securities anywhere else while the line of credit is outstanding.
- If the borrower defaults, the lender can directly seize securities to pay off the loan.
- The lender may restrict the type of securities in the pledged account to ensure that the collateral isn’t too volatile, and they’ll be able to recoup their losses.
- If the value of the securities falls to a point that makes the lender uncomfortable, they can compel the borrower to either sell securities or deposit additional cash.
A Securities-Backed Line of Credit can be a great tool to access liquidity from your investment portfolio without causing negative tax consequences. It also allows you to leverage the value of your assets while keeping your money invested in the market. If you are interested in using a SBLOC, please contact your RegentAtlantic advisor to determine if it is the right solution for you.
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.