Saturday 31 May 2008

Margin lending dilemma

The end of the financial year is nigh, so it's once again time to decide whether or not to pre-pay the next twelve months interest. The main benefit of doing so is that if it's paid before 30 June the entire amount is deductible in this year's tax return. The other potential benefit of pre-paying the interest is that the interest rate is fixed, rather than being variable if you are paying monthly. There appears to be little chance of an interest rate cut in the next twelve months, but some possibility that the interest rate might increase another 0.25% or 0.50%.

Each of my three margin lenders is offering different interest rates for prepaying twelve months interest. St George margin lending is offering 10.25%, but because we have our home and residential investment property loans with them we are "gold" clients, so I get a 0.25% discount on the interest rate, bringing it down to 10.00%. Yesterday I faxed in the paperwork to fix and prepay the interest on $70,000, which is almost the entire loan balance on this account.

I'll probably also fix and prepay most of the loan balance on my leveraged equities account, but I'll leave about $8,000 at the variable rate so I can reduce the loan balance at any time if I sell off some odd stock lots that were left sitting in this account after some takeover activity. Leveraged Equities usually mails me a prepayment form in early June, so I don't yet know what interest rate is on offer. Hopefully it will also be 10% or less.

My third Australian stock account on margin is with Commonwealth Securities (ComSec). They sent out a prepayment offer last week, but the interest rate on offer is an exorbitant 10.35%! This account has my largest margin loan balance (just over $150,000), so I'll have to phone them and try to negotiate a better rate. If they won't come to the party I'll consider transferring the holdings to my St George margin loan account. I'd rather not have to do so, as it might trigger a capital gains tax liability. It might also be a hassle arranging for the Comsec loan to be paid out if the shares on that account are transferred to my St George margin account.

The higher interest rate charged by ComSec seems even more excessive considering that they don't pay any trailing fees to brokers (as I found out from YourShare when I arranged to get a 50% rebate of trails on my various investment and loan accounts by making them my nominated broker). If I borrow funds from St George rather than ComSec I would get a rebate of trailing fees worth around 0.15% in addition to the interest rate being 10.00% rather than 10.35%

The interest rates on my margin loans have increased from around 8% a year ago, to around 10% today. There's considerable risk that the overall ROI of my stock investments won't exceed 10%pa in the medium term, which would make the use of gearing an ineffective investment strategy. However, most of my Australian stock holdings include considerable unrealised capital gains, so I'm not keen on selling stocks in order to reduce my margin loan balances at this time.

If interest rates drop and margin lending remains a useful investment strategy, I'm hoping to be able to liquidate these holdings gradually during my retirement. Under the current superannuation rules my SMSF pension income won't be taxable and doesn't even have to be included on tax returns. This would (I think) mean that it wouldn't be counted as income when working out the marginal tax rate to be applied to any capital gains realised during retirement. On the other hand, the Rudd government has indicated that they want to include such retirement pension income in some social security calculations, so presumably the data would then be available to the ATO and might end up also affecting capital gains tax calculations.

It's a bit hard trying to make sensible decisions about taxation planning when the rules can change at any time. In fact, some Labor politicians have expressed a desire to do away with the current 50% CGT concession for "long term" capital gains, so holding on to my stocks could end up costing me a lot extra tax in the long run. Perhaps I should hedge my bets by selling off a portion of my Australian stock portfolio and use the proceeds to reduce my margin loan balances. Of course, if I want to do that during the next financial year I can't fix and prepay the entire loan balance. Decisions, decisions...

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traineeinvestor said...

It's hard enough making investment decisions when you only have to guess the likely return on the investment. Having to guess about future tax and superannuation rules must be a real pain.

IIRC, when Australia first introduced capital gains tax in the 1980s there was an exemption for shares acquired before the tax took effect (which actually lifted the market a bit as investors tended to hang on to shares which would be exempt from the new tax). If they grandfather investments acquired before the tax rules change, it may pay to hang on to shares acquired pre-change.

Anonymous said...

Transferring your holdings from Commsec to St. George should not trigger a capital gains event as long as you are not transferring ownership from one entity to another: i.e. from a private company to you personally. Good luck.

mOOm said...

I closed my Leveraged Equities account and shifted the shares to CommSec - it was easy to do, but I was already using CommSec as broker. The reason I did it was that CommSec charged outrageous fees to transact on a non-CommSec margin loan (whereas TD Waterhouse hadn't). I did this while living in the US. Shouldn't be any CGT. I can see the tax review reducing corporation tax, abolishing dividend imputation and returning to indexing of capital gains rather than a 50% concession or reduced long-term concessions.

BTW Ameritrade charge 10.5% margin interest in the US, where the Federal Funds Rate is just 2.25%!

I have never prepaid interest here in Aus as I always plan to get my loan balance down and it is only a once off benefit of bringing the interest forward one tax year anyway. I have large margin loans now, but hope to get them down to almost nothing as the market rises... As you say, this kind of interest rate doesn't make a lot of sense.