Written by Robert T. Nickerson
With the coronavirus wreaking havoc on the U.S. economy, the federal funds rate has taken a nosedive, dropping from 1.75% in January to 0.25% as of June 10th. With rates projected to hover around 0% for the foreseeable future, now is a great time to leverage low interest rates in your estate planning strategies and help clients to maximize their wealth for themselves and their families even in times that are economically challenging. Below are three wealth transfer strategies to consider.
1. Passing on assets tax-free and locking in low “hurdle rates”
A grantor retained annuity trust (GRAT) is an excellent way to take advantage of the current low interest rates. As an irrevocable trust, a GRAT allows the grantor to transfer property into the trust and receive an annuity payment for a specific length of time. When the grantor passes away, the assets are handed off, tax-free, to the designated beneficiaries.
The Section 7520 interest rate is fixed by the Internal Revenue Code and is set as the “hurdle rate” at the time the GRAT is established. Section 7520 rates are currently low, so any appreciation of the trust’s assets above that hurdle rate gets passed tax-free to the trust beneficiaries at the end of the term specified in the GRAT document. With the interest rates so low, there is greater potential for a tax-free payout down the road. Additionally, because the assets belong to the trust, they will be passed on without triggering gift and estate tax liabilities.
2. Hurdle rates and charitable planning
A charitable lead annuity trust (CLAT) is similar to a GRAT—the only difference being that the fixed annuity payments go to a charity instead of the grantor, making it a great option for charitably inclined individuals. Also like a GRAT, a CLAT’s assets are assumed by the IRS to grow at the hurdle rate that is determined when the trust is created. Any appreciation above the hurdle rate passes tax-free to the beneficiaries at the end of the term set forth in the CLAT document.
3. Selling appreciating assets to a grantor trust
Another way to lessen tax liability and pass on more money to trust beneficiaries is to consider selling appreciating property to an intentionally defective grantor trust (IDGT). IDGTs are effective for estate tax purposes but “defective” for income tax purposes, meaning that the grantor — not the trust — pays tax on income earned in the trust, allowing trust assets to grow. The interest rate that must be charged on the promissory note is the applicable federal rate as of the month of the sale. With interest rates currently so low, property sold to the trust is more likely to earn a higher rate of return than the interest on the loan. Asset appreciation will accrue to the trust rather than the donor. Once sold to the trust, the property is no longer considered to be a part of the grantor’s estate. Assets sold to the IDGT will be excluded from the grantor’s gross estate to the extent the grantor outlives the term of the note.
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Jeffrey C. Nickerson - Estate Planning Attorney - My Passion is Special Needs Planning!