Estate Planning Strategies in a Low-Interest-Rate Environment
The federal government requires the use ofcertain interest rates to value various itemsused in estate planning, such as an income,annuity, or remainder interest in a trust. Thegovernment also has interest rates that ataxpayer may be deemed to use in connectionwith certain installment sales or intra-familyloans. These rates are currently at or nearhistoric lows, presenting several estateplanning opportunities.Low interest rates favor certain estate planningstrategies over others. For example, lowinterest rates are beneficial for a grantorretained annuity trust (GRAT), a charitable leadannuity trust (CLAT), an installment sale, and alow-interest loan. On the other hand, lowinterest rates have a detrimental effect on aqualified personal residence trust (QPRT) or acharitable gift annuity. But interest rates havelittle or no effect on a charitable remainderunitrust (CRUT).
Grantor retained annuity trust (GRAT)
In a GRAT, you transfer property to a trust, butretain a right to annuity payments for a term ofyears. After the trust term ends, the remainingtrust property passes to your beneficiaries,such as family members. The value of the giftof a remainder interest is discounted for gift taxpurposes to reflect that it will be received in thefuture. Also, if you survive the trust term, thetrust property is not included in your grossestate for estate tax purposes. If the rate ofappreciation is greater than the IRS interestrate, more of the value of trust assets escapesgift and estate taxation. Consequently, thelower the IRS interest rate, the more effectivethis technique is.
Charitable lead annuity trust (CLAT)
In a CLAT, you transfer property to a trust,giving a charity the right to annuity paymentsfor a term of years. After the trust term ends,the remaining trust property passes to yourbeneficiaries, such as family members. Thistrust is similar to a GRAT, except that you get agift tax charitable deduction. Also, if structuredso that you are taxed on trust income, youreceive an up-front income tax charitablededuction for the gift of the annuity interest. Thelower the IRS interest rate, the more effectivethis technique is.
You may also wish to consider an installmentsale to family members. With an installmentsale, you can generally defer the taxation ofany gain on the property sold until theinstallment payments are received. However, ifthe family member resells the property withintwo years of your installment sale, any deferredgain will generally be accelerated. The two-yearlimit does not apply to stocks that are sold onan established securities market.You are generally required to charge anadequate interest rate in return for theopportunity to pay in installments, or interestwill be deemed to be charged for income taxand gift tax purposes. However, with the currentlow interest rates, your family members can payfor the property in installments, while payingonly a minimal interest cost for the benefit ofdoing so.
A low-interest loan to family members mightalso be useful. You are generally required tocharge an adequate interest rate on the loan forthe use of the money, or interest will bedeemed to be charged for income tax and gifttax purposes. However, with the current lowinterest rates, you can provide loans at a verylow rate and family members can effectivelykeep any earnings in excess of the interest theyare required to pay you.
Effect of low rates on other strategies
Charitable remainder unitrust:
You retain astream of payments for a number of years (orfor life), after which the remainder passes tocharity. You receive a current charitablededuction for the gift of the remainderinterest. Interest rates have no effect ifpayments are made annually at the beginningof each year, and low interest rates have onlya minimal detrimental effect if payments aremade in any other way.•
Qualified personal residence trust:
Youtransfer your personal residence to a trust,retaining the right to live in the home for aperiod of years, after which the residencepasses to your beneficiaries, such as familymembers. The value of the gift of a remainderinterest is discounted for gift tax purposes toreflect that it will be received in the future.The lower the IRS interest rate, the lesseffective this technique is.•
Charitable gift annuity:
You transferproperty to a charity in return for the charity'spromise to make annuity payments for yourlife (or for you and your spouse's lives). Youreceive a current charitable deduction for thegift of the remainder interest. The lower theinterest rate, the lower the amount of yourcharitable deduction will be. Also, charitieshave generally been forced to reduce payoutrates offered because of the economicdownturn and the low-interest-rateenvironment.
Low interest rates favor certain estate planning strategies over others, and the interest rates used by the IRS are at or near historic lows.
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