Timely Estate Planning Strategies: Part Two

Oct 21, 2021

Low-Interest Rate Opportunities

An important component of personal financial and estate planning often includes transferring assets and future growth of those assets to younger generations or to charitable organizations while reducing current income taxes and future potential estate taxes. Once properly made, appreciation of such transfers and any future income generated thereon can be free of transfer taxes.

The current low-interest-rate environment provides an excellent opportunity to shift wealth to future generations. While we cannot predict the future, we can anticipate the writing on the wall. As noted in our previous post, Estate Planning Strategies Before Year-End: Part One, recent and proposed massive spending by the federal government will likely put pressure on rates. This coupled with various proposals to modify tax laws relating to gift and estate taxation, individuals should plan on implementing any such plans sooner rather than later.

Planning techniques benefitting from lower rates include the following:

1. Charitable Lead Annuity Trust (CLAT). This trust can be set up to provide annual distributions to charity for a specified number of years. Any growth in the value of the assets above the applicable federal interest rate passes to the non-charitable remainder beneficiaries (i.e. the taxpayer’s children) free of estate or gift tax at the termination of the trust.

2. Intra-Family Loans. It’s a good time to loan money to family members or trusts for members’ benefit. Interest can be charged at very low rates; to the extent the borrowers are able to leverage the funds to generate a return greater than the stated rate, wealth will be transferred without any transfer tax.

3. “Defective” Grantor Trusts. When a taxpayer (grantor) transfers assets to fund this trust, certain rights might be retained causing the trust to be “defective”. This may include the right to substitute other assets of equal value in future years. As a result, the annual income of the trust remains taxable to the grantor even though the income inures to the benefit of the beneficiaries. The effect of this is to reduce the grantor’s taxable estate by the amount of the income taxes paid annually. These trusts are often used to sell assets expected to grow in the future to the trust in exchange for a low-interest rate promissory note. The grantor does not recognize gain from the sale, and no income is recognized on the interest payments. The appreciation in the assets will be realized by the next generation without any transfer tax.

4. Charitable Remainder Trust. If a current income tax deduction is more important than saving transfer taxes, this trust may be implemented. The trust will make annual payments to its beneficiaries for a period of time. At the termination of the trust, the principal balance goes to the specified charity. This “remainder interest” is calculated at a present value to determine the current charitable contribution income tax deduction available to the donor. Lower interest rates translate to a larger remainder interest, and thus larger income tax deduction.

5. Grantor Retained Annuity Trust (GRAT). A grantor transfers assets to the trust and retains the right to receive specified payments from the trust for a specified number of years. At the end of the trust term, the accumulated principal of the trust passes to the specified donees, often the grantor’s children.

The annual payments can be structured so that the present value of the annual payments will equal the value of the property transferred to the trust. The trust is said to be “zeroed-out” because the donees’ remainder interest has no value for gift tax purposes, thus no gift tax exemption is used and no gift tax is due. To the extent, the increase in the value of the assets exceeds the annuity stream paid to the grantor, the assets remaining in the trust pass to the beneficiaries becoming a tax-free gift.

These are just some of the planning opportunities your William Vaughan advisor can discuss with you. We encourage you to take this important step now to avoid potentially detrimental changes which have been proposed in Washington. Early adoption and implementation have perhaps never been more important.

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Categories: Estate Planning, Tax Planning