Pulling cash from shares

THERE are ways to extract cash from a booming share market that won't attract a hefty tax bill.

Pulling cash from shares

THE problem with a booming stock market is that it's difficult to realise the gains in cash without a hefty tax bill.

It's therefore worth looking at alternative ways to extract cash. Most investors will be familiar with margin lending to gear up their portfolios. But recent market volatility caused by the sub-prime crisis was an uncomfortable reminder that margins calls do occur.

There are other options, depending on the sophistication of the investor. Cash can be raised against shares with less risk than margin lending with products such as protected-equity loans or instalment warrants.

"I think people are a little more willing to pay for protection now given the bull markets we have seen in recent years,'' says Karen Novak, private wealth executive planner at Westpac Private Bank.

"On a margin lending facility now you are probably paying around 9.4 per cent interest per annum. On a protected-equity loan you are looking at probably, on a five-year loan, anywhere between 12 and 14 per cent interest per annum on average. That's the difference that you are paying for that protection.'' 

A protected-equity loan allows the investor to buy a portfolio of shares by borrowing 100 per cent of the funds.

The loan has an embedded put option and if the value of any of the shares tanks, the lender simply takes the share portfolio without recourse to the investor.

The downside is that with a high interest rate the investor needs to have a reliable income stream to pay the loan. Many investors will take an interest-only loan to maximise tax deductions.

The instalment warrant involves buying the share on a "payment plan''.

The investor pays an initial payment then in the future the completion payment is required. The investor receives dividends and franking credits. The benefit of the warrants is that they enable you to double your exposure to that stock.

Accountants and financial planners say the product is only for sophisticated investors.

Mr Novak says even sophisticated investors comfortable with many markets can be shy of warrants.

"Many people find it tough to understand equities, let alone derivatives of the underlying security.''

He says instalment warrants can be useful for those who want to rebalance their portfolio.

"There may be people who have worked for a company for many years and may have accumulated many shares in that company. If this share represents a very large weighting in the total portfolio, it may be wise to diversify.''

The cash-extraction strategy generally only works with blue-chip shares as each issuer of warrants has an approved list. A form of warrant is self-funding instalment warrants. With these the dividends pay the loan balance.

Stephen Horton of Warranted Financial Solutions (WFS), a boutique broker and investment adviser specialising in investment warrants, says: "The beautiful thing about what I can do is that I can reduce the interest upfront and I can capitalise the second payment, the third payment and the fourth payment. In other words, I can create a loan arrangement whereby, after the first interest payment, you can capitalise.

``The interest rate gets reset at the maturity date of each instalment. For example, with Macquarie Bank they do a lot of June 30 instalments. If you go with JP Morgan, they do a lot of May instalments.''

Typically, Westpac will issue instalment warrants with a 50 per cent gearing ratio but other institutions, such as Macquarie, will issue them at much higher ratios.

For example, an investor with $100,000 of BHP shares could decide to exchange the shares for $200,000 BHP warrants with full access to the franking credits and the dividends of all the shares.

"The benefit of the instalment warrants is that you are getting double the exposure to that one stock,'' Mr Novak says.

The investor gets double the dividends and franking credits, which goes towards paying down the loan balance in the case of self-funding instalments.

"It's like buying shares on lay-by really. The major thing with margin lending is the margin call. Self-funding instalment warrants can be a set-and-forget strategy if you buy good quality blue-chip stocks.''

And the cash can be used for anything. Reinvestment in the stock market is the prudent option and can be used to help correct unbalanced portfolios. Horton says the cash raised can be used, for instance, as a cheaper alternative to leasing a luxury car.

He says that a $100,000 car bought with a lease over three years, with a 40 per cent residual payment, would require more than $30,000 earned pre-tax to make the lease payments.

Instalment warrants can be structured so no repayments are required in years two and three.

By contrast, a portfolio of shares could be sold to raise the cash but would attract capital gains tax.

"Assume the cost of the portfolio four years ago was $80,000 and it's now worth $180,000. Should the owner seek $100,000 cash, he or she could be up for as much as capital gains tax of $43,000,'' Mr Horton says.