What is margin?
Margin is a loan secured by an investment account as collateral.
Why is margin a problem during an estate administration?
Margin typically survives the death of the account holder. However, the account upon which the loan is secured is often frozen because the account holder died. This means the loan continues to charge interest even if you cannot access the underlying securities because the account is frozen. This means that if the collateral (i.e. the investment account) is frozen and inaccessible until someone gets appointed or it passes to a named beneficiary, because of this, the following scenarios are likely:
In a best-case scenario, the loan is still active, accruing interest, and the account cannot be closed/retitled/paid to a beneficiary/the estate until the margin loan is paid (and the balance continues to rise as time passes, which is not a good look for a fiduciary in most circumstances).
- Payment of the loan often involves selling the underlying stock securing the loan. You don’t have to do that though. You can repay however you like. Remember though that the tax basis of the stock gets stepped up at death, so, as long as the stock is sold quickly after death and the loan gets repaid, there is usually little to no gain/loss.
In a worst-case scenario, you can run into loan-to-value (“LTV”) issues if the market dips - which can accelerate loan repayment. (i.e., a Margin Call).
How to handle this during an estate administration:
Your clients will often look to you as their trusted advisor to assist with this during the estate administration. It is important to act quickly in these scenarios as time is not your friend when handling a margin account in an estate administration.
Whether you are a financial advisor, estate lawyer, or an executor client, the first step is to find out whether any accounts in the name of the decedent have a margin loan outstanding.
The executor has a fiduciary duty to the estate to do everything they can to safeguard estate dollars from avoidable interest fees and margin calls. If one or more of them have a margin loan outstanding, prioritize the repayment and closure of such loans FIRST.
In order to repay the loan, advise the client to meet with one or more financial advisors (usually the advisor for the decedent's account if they are amenable, as well as their current financial advisor if they have one) and determine which stocks make the most sense to sell off. It is important to also look at the decedent’s entire portfolio and balance sheet (if you have access to this information). If they have liquidity elsewhere (perhaps cash accounts that could pay off a large portion of the loan) and there aren’t any other liquidity needs (for instance, if the decedent had properties with ongoing carrying costs that will need to be dealt with over the next several months or other interest-bearing loans /liabilities at higher rates), it might be prudent to pay off the loans with assets other than the brokerage account’s stock. This is a judgment call that is best made by the client when their financial advisory team is assisting them. It is important, as the attorney, to know your limits on where your legal advice starts and ends so that you don’t cross over into giving financial advice.
If a portion of the stock in the investment account makes the most sense to liquidate, and once the client has made an informed decision on what stock to sell, this is where you, as the attorney can step back in to make sure that the stock sales in the decedent’s account get stepped up to the decedent’s date of death. We recommend using a service like Trustate to ensure that all paperwork for the sales, or, if the client needs to contact the trading desk to sell, that all stock basis information is correct and updated to the decedent’s date of death.
Exceptions: There are some exceptions to the general rule where it is not prudent for the client to pay off the margin loan and they are best served to keep it until the last minute. Some of these circumstances might be where there are other, more urgent liquidity needs, such as other liabilities with higher interest rates, carrying costs of real property that need to be up-to-date to sell (certain HOAs, property tax, certain condo and management fees) in a “top of the market” environment where it behooves the executor to sell as quickly as possible. Or, where there is a liquidity need in the estate itself and a margin loan needs to be taken out in the first place and the market or underlying investments are extremely stable/in a conservative portfolio with low-interest rates. Most well-drafted wills and trusts actually contain language to allow the executor/trustee to use margin or take out a margin loan on stock owned by the trust/estate for this very purpose.
Issues can be avoided! How creating an Estate Plan can avoid these issues in the first place:
- Always ask your clients if any accounts have margin loans during the estate planning consultation.
- If there is an account with a margin loan, ensure the account has a named beneficiary so that the account is not frozen until an executor is formally appointed by the court. (Note that if you want the account to pass in trust, use a pour-over will/revocable living trust plan and name the trust as the beneficiary. Often you won’t be able to retitle the account during the holder’s lifetime into the name of the trust because of the margin loan, but at least naming the trust as a death beneficiary will enable the Trustee to act as soon as the account holder dies.)
- Meet your client’s wealth manager and ensure that they monitor the market as it relates to these accounts to avoid any LTV issues.