Take advantage of low and high interest rates for wealth transfers


The current war in Ukraine has fueled the fire of inflation that ignited in the aftermath of the Covid-19 pandemic and the fiscal stimulus measures implemented in response. It seems likely that the Federal Reserve will raise interest rates, perhaps as much as 2% over the next year to 18 months.

As interest rates rise, changing rates affect estate planning. There are strategies that are more effective in high interest rate environments as well as strategies that are more effective in low interest rate environments. There is no “one size fits all” strategy for high and low rate environments Since 2010 and into 2021, interest rates have reached historic lows, reflecting low rates of inflation. Now inflation is on the rise and most likely interest rates will follow. When interest rates start to rise, it’s time to change strategy; and, as long as interest rates remain low, implement the most effective strategies in a low interest rate environment. When the Fed raises rates, implement the strategies that work best when interest rates are higher.

What Interest Rates Affect Estate Planning

Each month, the Internal Revenue Service publishes the short, medium, and long-term rates (the applicable federal rates, or AFR) and the §7520 rate. AFRs reflect the minimum interest rate that must be charged for related party loans; the §7520 rate (used to calculate annual payments for certain techniques) is 120% of the medium-term AFR. All of these rates are calculated based on the yields of certain government debt securities, and the target federal funds rate has a direct impact on these yields. Since the AFR and the §7520 rate are used when implementing a number of estate planning techniques, the effectiveness of these techniques changes when these rates change. Rising interest rates can motivate you to lock in interest rates while they remain low or prepare to capitalize on potentially higher rates in the future.

Usually, the rate that will apply to a specific strategy is the rate in effect on the date the strategy is implemented. Thus, you should consider which strategies are most effective in the changing interest rate environment and how these affect your financial goals.

Strategies for the current low interest rate environment

Planning in today’s low interest rate environment often involves lending strategies that take advantage of low interest rates to transfer wealth with little or no gift tax. At their core, these strategies involve older family members lending money to younger family members at the relevant interest rate; the proceeds of the loan are invested by the youngest members of the family. The interest rate reflects the hurdle that investment growth must overcome before the strategy is successful in transferring value to younger family members. For example, the §7520 rate for March 2022 is 2.0%. If you loan a child $1,000,000 now, the interest rate will be 2%. If, as interest rates rise, the child actually earns 8% on the funds, the child will receive the difference between the interest rate paid (here $20,000) and the amount received from the loan proceeds invested (here $80,000), for a net profit of $60,000, tax-free donation. This technique allows wealthier family members to “freeze” the value of the assets they lend, which would typically be included in their estates for estate tax purposes, and pass on the appreciation of the asset to less wealthy family members or trusts for their benefit.

The intra-family loan is the simplest way to implement a low-rate environment strategy. A cash loan can be structured as an interest-only loan with a lump sum payment at maturity; if the assets purchased by the borrower with the loan proceeds appreciate more than the interest rate paid on the loan, the excess passes to the borrower free of gift tax.

Another low-interest strategy is an installment sale to an intentionally defective grantor trust (IDGT): This is similar to an intrafamily loan, but the borrower is a trust created by the lender; the borrowing trust is a “granting trust” in relation to the lender for income tax purposes (meaning the lender/grantor is liable for all income tax, including capital gains tax , incurred by the trust), and the asset sold to the trust or the property in which the loan money is invested is often a non-cash asset, such as shares of a closely held company. Since the lender and the borrower are the same taxpayer, no gain is realized on the sale of the asset to the trust. And because the lender is required to pay tax on the trust’s income, the loaned assets can grow inside the trust without being depleted by income tax payments. Also, the appreciation of the asset relative to the interest rate accrues to the beneficiaries of the trust without gift tax. This structure also uses the corresponding AFR.

A third strategy for low interest rate environments is the Grantor Retained Annuity Trust (GRAT). The GRAT acts like an installment sale to an IDGT, except that annual payments to the grantor must be fully amortized over the term of the GRAT, and the §7520 rate (which is higher than short- and medium-term AFRs) must be used. Appreciation above the §7520 rate accrues to the beneficiaries of the trust. The economic benefits of this strategy are often less significant than those of the installment sale strategy, since the annuity includes portions of interest and principal. It is, however, possible to create a series of short-term, rolling GRATs (the donor funds a new GRAT each year with the annuity from the previous GRAT) rather than a single longer-term GRAT, to increase the benefits of the wealth transfer. . and capitalize on market volatility.

Finally, there is the Charitable Lead Annuity Trust (CLT). Like a GRAT, asset appreciation above the §7520 rate is passed on to the beneficiaries of the trust tax-free. Unlike a GRAT, annuity payments during the term of the trust are paid to the charity and not to the settlor, who is therefore unable to continue to benefit from the assets contributed to the CLT. Depending on how the CLT is structured, the donor may receive either a charitable donation tax deduction or a charitable income tax deduction in the year the CLT is funded.

Strategies for a high interest rate environment

As interest rates rise, you can leverage high interest rate strategies to reduce the actuarial value of a taxable gift. The higher the rate, the more beneficial these strategies will be.

First, there is a qualified personal residence trust (QPRT). A QPRT is a trust used to transfer personal residence to the beneficiaries of the trust. The QPRT lasts for a number of years, during which the grantor can continue to use the residence as their own. After the initial term of the QPRT, residency passes to the remaining beneficiaries. If the settlor wishes to continue to live in the unit, the trust or its beneficiaries may rent it to the settlor for fair market value rent. The initial transfer to QPRT is a taxable gift of the value of the remaining interest, calculated using the §7520 rate. The higher the rate, the higher the value of the settlor’s right to use the residence as his own for the duration of the years and the lower the value of the gift of future residual interest. Thus, as the §7520 rate increases, the taxable gift decreases, making QPRT a more attractive strategy with higher interest rates.

Second, there is the Charitable Remainder Annuity Trust (CRT): With a CRT, the settlor receives an annuity from the CRT for a term of several years, and the charity receives whatever remains at the end of the term. Here, the value of the remainder, calculated using the §7520 rate at the time the settlor creates the trust, gives the settlor a charitable income tax deduction. However, to pass the IRS review, the value of the remainder must meet a minimum threshold; the higher the §7520 rate, the greater the value of the charitable interest and the more likely the CRT will pass IRS review. CRTs must also make a minimum annual payment to the licensor; young licensors who wish to create certain CRTs may find it more difficult to meet this minimum payment if the rates are too low.

So, in today’s low interest rate environment, you should consider setting up: 1) intra-family loans, 2) loans to an intentionally defective grantor trust, 3) donations through an annuity trust retained by the grantor and 4) a charitable master annuity trust. . As interest rates rise, you should consider a qualified personal residence trust and a charitable residual annuity trust. Either way, it pays to plan ahead for low and high interest rate environments in these volatile times.


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