Tag Archive: Brokerage

Substitute Dividend Payments in Margin Accounts

I have a margin account with  eOption for a couple of years now. When I first signed up, they have among the lowest margin interest rates in the industry, They have since adjusted the rates upwards, following the footsteps of Tradeking, Just2Trade, etc.

I spoke to customer service when the rates were first revised and they agreed to grandfather me to the more-friendly rate schedule. This more-friendly rate schedule is still available at their sister brokerage Investrade.com.  The current rate is as follows:

The current Broker’s Call Rate is 2.00% as of 12/19/2008

Daily Average $ Debit Balance

Interest Rate

Less than 49,999 1.50% above broker call rate
50,000 to 99,999 .75% above broker call rate
100,000 to 249,999 at broker call rate
250,000 to 499,999 .50% below broker call rate
500,000 and above 1.00% below broker call rate

Anyway, I started taking advantage of their low margin rates but in the first quarter, I was hit with a substitute dividend payment in an ETF I was holding in that account. This is the definition of a substitute payment from Fidelity:

Substitute Payments
Substitute payments are payments received in lieu of dividends, interest, or other payments. They may be generated, for example, where a security has been lent to a third party (such as a broker) over a dividend record date. When an investor has a debit balance in a margin account, securities in the account are often eligible to be lent. If the shares are lent over a record date, the investor should receive a substitute payment equal to the amount of the dividend. Although the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) introduced lower federal tax rates for qualified dividend income, substitute payments are not taxed as qualified dividends but are instead taxed as ordinary income. Substitute payments in lieu of dividends and tax exempt interest are reportable in Box 8 of Form 1099-MISC.

So basically, with a substitute dividend payment, you get taxed at the full income tax rate instead of the preferential (15% for most tax payers) qualified dividend tax rate (if the dividend was originally qualified).

The negative consequence of this could be huge. For an ETF like VEA, I could get a year-end dividend in the range of a few thousand dollars. If it gets disqualified, my additional taxes could run into several hundred dollars.

There are a few ways to avoid this

  1. Move the assets to a brokerage that “gross-up” the dividends to compensate for the additional taxes you have to pay. I only know of two brokerages that have this voluntary program — Fidelity and TD Ameritrade. As far as I know, VBS (Vanguard) and WellsTrade do not offer this. eOption also does not offer this. Edit: Schwab also offers this voluntary “gross-up” program.
  2. Move the assets to the cash position. Some brokerages let you specify the “account type ” of each asset, whether it is “cash” or “margin”. eOption offers this and I moved the assets that potentially produce qualified dividends to “cash”. I left the non-dividend producing assets in “margin”. I don’t believe VBS lets you do this though; all the assets in each account must be the same “type” in VBS.
  3. Do not keep a debit balance. If we read Fidelity’s definition carefully, it says that if “an investor has a debit balance in a margin account, securities in the account are often eligible to be lent”. So technically if there is no margin balance, no shares should be loaned out. Personally, I do not regard this method as a fail-safe method. When you sign on the dotted line for a margin account, you are already giving permission to the broker to lend out your shares. It could be possible that the broker will refrain, as far as possible, from lending out your shares in this scenario, but I think there is no guarantee that this would never happen.

Note: FWIW, my experience is that method 3 seems to be true. Until the eOption experience, I have never received a substitute payment with the many margin accounts I have had over the years. The reason could be simply because I have never kept a margin balance except at eOption.


[1] http://www.fool.com/personal-finance/taxes/2003/12/05/dividend-tax-breaks-at-risk.aspx

Less than 49,999 1.50% above broker call rate
50,000 to 99,999 .75% above broker call rate
100,000 to 249,999 at broker call rate
250,000 to 499,999 .50% below broker call rate
500,000 and above 1.00% below broker call rate

Adios to Wells Trade

As I was reviewing some old notes I had of  Wells Trade, the investment arm of Wells Fargo, I see a trend that Wells Fargo has been trying hard to make some money out of these “free-trade” accounts:

  • 02/2008 : Introduced 100 free trades for PMA package with $25k or more.
  • 08/2008 : Eliminated the respectable money market sweep funds and replaced them with a crappy bank account sweep.
  • 12/2008 : Eliminated RMMXX, a relatively high yield MMF at that time, for purchase.
  • 01/2009 : Close out fee increased from $50 to $75.
  • 03/2010 : Close out fee to increase to $95.

In addition, Wells Fargo has been “cracking down” on people who did not actively use the checking account of the PMA package. These accounts are marked as “dormant” and quite a few people reported having to jump through some hoops to re-activate them again.

With the talk of additional tax on big banks, I won’t be surprised to see another round of fee increase on the horizon. The money for the taxes has to come from somewhere.

Wells Trade did have some good points. Their reps are quite friendly and helpful, and the trading system, while nothing fancy, generally works. They also introduce a good online feature, which is the capability to track and specify specific tax lots for trading, very helpful for a taxable account.

Anyway, because of my upcoming Roth conversion, I am done with Wells Trade. I will be contributing $75 to them for the free trades they have given me over the past three years or so when I close out my accounts later this month. Good luck to all those sticking with Wells Trade.

Brokers With Lowest Margin Interest Rates

Recently I did some research into brokers with low margin interest rates and with low trading commissions ($3 or less per trade). Since I already had them all typed out in my notes, I thought I would post them in case someone else might find it useful. The rates are valid on or around April 28, 2009.

eOption.com (affiliated with placetrade and investrade) (see important update below)

  • BC + 1.5% = 3.5% for up to $50,000
  • BC + 0.75% = 2.75% for $50,000 to $99,999
  • BC + 0.0% = 2.0% for $100,000 to $249,999
  • BC – 0.5% = 1.5% for $250,000 to $499,999
  • BC – 1.0% = 1.0% for $500,000 and above
  • Interest @ 2.75% for $80k a month = $183.33, after tax = $100.83
  • Interest @ 2% for $100k a month = $166.67, after tax = $91.67
  • Trading fees : $3 per ticket
  • ACH transfer limit = $50,000 a day


  • BC + 0.75% = 2.75% for up to $100,000 (confirmed with them that there is a typo on their margin rates page)
  • BC + 0.5% = 2.50% for $100,000 to $250,000
  • Interest @2.75% for $80k a month = $183.33, after tax = $100.83
  • Interest @2.50% for $100k a month = $208.33, after tax = $114.58
  • Trading fees : $2.50 per ticket

Interactive Brokers

  • BM + 1.5% = 1.65% for up to $100,000
  • BM + 1% = 1.15% for $100,000 to $1,000,000
  • BM = Feds fund rate = 0.15%
  • Interest @1.65% for $80k a month = $110.00, after tax = $60.5 + $10 monthly fee
  • Interest @1.15% for $100k a month = $95.83, after tax = $52.71 + $10 monthly fee
  • Minimum fee $10 a month
  • Trading fees : 0.005 per share, minimum $1
  • 2nd withdrawal in the month : $1 by ACH, $4 by check, $10 by wire

Options House

  • BC + 2.25% = 4.45% for up to $50,000
  • BC + 1.45% = 3.45% for $50,000 to $499,999
  • BC + 0.45% = 2.45% for over $500,000
  • Interest @ 3.45% for $80k a month = $230, after tax = $126.5
  • Trading fees = $2.95 per ticket

WellsTrade (Wells Fargo) (called 4/28/09 10.10am)

  • WFI, Wells Fargo base rate = 4.00%
  • WFI + 3% = 7% for up to $10k
  • WFI + 2.75% = 6.75% for $10k to $25k
  • WFI + 2.25% = 6.25% for $25k to $50k
  • WFI + 1.75% = 5.75% for $50k to $100k
  • WFI + 1.25% = 5.25% for $100k to $250k
  • Trading fees : up to 100 free trades a year

Note: BC is the broker call rate, currently 2%. The “after tax” number reflects a 45% combined federal and state marginal income tax bracket.


The absolute lowest rates are from Interactive Brokers but they want to charge you a minimum of $10 in trade fees a month. If your trade fees do not add up to $10, they will deduct $10 anyway.

The next best rates are from eOption.com — at BC = 2% for amounts from $100k to $250k. This rate is lower than the interest rates from leading savings accounts, and is also cheaper than a HELOC loan.

I included the margin schedule at WellsTrade for comparison only because I have an account there. Their rates are not at all competitive.

I also looked at some other brokerages like Fidelity, VBS (Vanguard), TD Ameritrade, Scottrade, Firstrade, Tradeking, Etrade, Charles Schwab, Options Express, Sogotrade, MB Trading. Their rates are all higher.

Other resource(s)

[1] List from Broker Reviews.

Update 8/03/2009

eOption increased their margin rates as of 8/1/09. The new schedule is as follows (BR, base rate is 5%):

  • BR = 5.0% for up to $50,000
  • BR – 0.5% = 4.5% for $50,000 to $99,999
  • BR – 1.0% = 4.0% for $100,000 to $249,999
  • BR – 1.5% = 3.5% for $250,000 to $499,999
  • BR – 2.0% = 3.0% for $500,000 to $999,999
  • BR – 2.5% = 2.5% for $1,000,000 and above