The hazards of securities-based lending as a source of retirement income

Hold onto your hats and proceed with caution

Feb 11, 2015 @ 2:37 pm

By Darla Mercado

Securities-based lending is emerging as a possible way to fund short-term expenses in retirement, but experts warn that advisers ought to use abundant caution when working with this strategy.

Securities-based lending allows clients to tap a line of credit by pledging a portfolio of assets in a taxable account as collateral to a bank. There are currently programs in place at Morgan Stanley, Wells Fargo and Raymond James.

The programs have been money makers for banks in recent years, as a rising stock market is making people feel more flush and thus comfortable making large purchases.

The funding strategy was back in the news this week when Michael Crook, head of portfolio and planning research at UBS, mentioned it at the Investment Management Consultants Association's New York consultants conference on Monday.

Advisers in the Twitterverse reacted with some measure of incredulity.

Mr. Crook was not immediately available for comment.


Thomas J. Anderson, author of “The Value of Debt in Retirement,” describes securities-based lending as “a sibling of margin,” which allows you to use your investment portfolio as collateral to buy more stocks.

“You borrow against investible assets, but securities-based lending is priced on the client's ability to borrow, while margin is priced based on how much you borrow,” he explained.

There is no upfront cost to set up a securities-based line of credit, and the interest rate is generally around prime, the rate banks generally give their best business customers. That rate is currently about 3.25%. Typically, it takes about five days to three weeks to set up one of these lines, he added.

Bill Geis, executive vice president of Raymond James Bank, noted that industrywide, there aren’t any set repayment terms, but that generally interest is due every month and principal is due on demand. Clients can also permit interest to accrue, but it’s important that they understand the implications of allowing that to happen. Historically, these loans can take as short as one week to repay, up to about three years, Mr. Geis added.

Looking at it from a financing point of view, clients can generally get a better deal through a securities-based line of credit compared with a traditional loan from a bank, according to Mr. Geis.

“In a roundabout way, this has supplanted some of the more traditional bank financing for some things,” he said. “The reason is that it becomes easier for the client to borrow, and on more favorable terms, because they own that portfolio of securities.”

It also allows the client to obtain money readily without having to cash out of his investments.

When using a securities-based line of credit, clients tend to use them for a number of reasons, including financing a business, snapping up a piece of real estate or buying luxury items. Mr. Geis noted that clients have tapped these lines of credit to help cover the cost of unexpectedly large tax bills, too.

However, as Mr. Crook pointed out, they can also be used in the context of a retirement income strategy.


In much the same way a client may not want to liquidate assets to cover large unexpected costs, clients can tap that line of credit for retirement income needs.

“When you borrow money from the portfolio, that money isn't taxable,” noted Mr. Anderson. “When you sell, you trigger a tax event. [With this strategy], you still own the underlying asset when you borrow, so it's possible to create tax efficient retirement income using a borrowing strategy.”

Mr. Geis noted that most of these loans tend to be short-term, however, so think of it as income in a pinch that will have to be repaid.

But that strategy requires a light touch and a great deal of due diligence on the part of the adviser. Nobody wants to be over-leveraged, particularly in retirement — and this strategy must be suitable for the client.

“Just like certain investments aren't for everyone, certain types of borrowing aren't for everyone as well,” said Mr. Geis. “Certain clients have proven they don't have the wherewithal to handle debt.”

And there are plenty of other risks. Consider that the bank can demand repayment of the amount at any time, warned Mr. Anderson, who recommended clients not use up more than 50% of the line of credit extended to them.

“Maybe the client gets some home repairs done, and the balance is going up, and suddenly the market goes down,” he said. “When that happens, if you violate your coverage ratio on these loans, the firms that were so nice extending the credit will call and tell you that they're selling the assets if you don't give them $15,000.”


Retirement income experts were less than thrilled about the idea of using debt to fund income needs. Consider the fact that 65.4% of American families with head of household aged 55 or older had debt in 2013, up from 63.4% in 2010, according to the Employee Benefit Research Institute.

“When the markets are going up, it might be fine, but this may be problematic when the markets go down,” said Wade Pfau, professor of retirement income at The American College.

Thus, in a pinch, consider other accessible sources of short-term funding, such as home equity loans, for example.

“I find it hard to believe that anyone with a sizeable portfolio is going to take on these loans,” said David Blanchett, head of retirement research at Morningstar Investment Management. “Anyone with a reasonably sized portfolio has something they can access in the short term for liquidity.”

A home may be a relatively stable asset to borrow against, but that's not necessarily the case for an investment portfolio, he added, where a client can be “double whammied” if stocks fall and he or she still needs liquidity.

“[Securities-based lending] could be another arrow in the quiver and may work for some clients given a unique fact pattern,” Mr. Blanchett added. “But any adviser doing their job should be aware of the options to create liquidity if the client needs it. In most situations there are other traditional forms of liquidity.”


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