When Interest Rates are Low, it’s Time for Estate Planning – Katie Lejong, Landmark CPAs

In a volatile economic environment, the idea of making substantial gifts may give you pause. But with interest rates at historic lows and the value of many assets depressed, now may be an ideal time for estate planning. Current conditions present an opportunity to transfer substantial wealth to the younger generation while minimizing your exposure to estate and gift taxes. And many estate planning strategies provide you with an income stream, which can give you peace of mind in uncertain times. 

Estate Planning: Why Now?

Reducing the size of your estate may not seem like a pressing concern. After all, the federal estate and gift tax exemption is a staggering $11.58 million ($23.16 million for married couples). But even if your net worth is substantially lower than that, it’s important to keep in mind that the exemption will likely shrink in the near future.

For one thing, the current exemption, which was established by the Tax Cuts and Jobs Act of 2017, is scheduled to be cut in half at the end of 2025. Plus, there’s a strong possibility that the U.S. Congress will act sooner than that to boost tax revenues. One proposal, for example, would reduce the estate tax exemption to $3.5 million and the gift tax exemption to only $1 million.

So, regardless of the size of your estate, it’s a good time to implement strategies that allow you to leverage low interest rates. Here are some estate planning tools to consider.

All in the Family

Lending money to your children or other family members is a simple — yet deceptively powerful — strategy for removing wealth from your estate with minimal transfer tax implications. It’s critical, however, to structure the loan carefully to prevent the IRS from arguing that the transaction is a disguised gift. To avoid an IRS challenge, you should treat the loan as you would an arm’s-length transaction with an unrelated party. That means, among other things:

How does a loan reduce transfer taxes? The key is for the borrower to invest the funds in assets that outperform the AFR. That hurdle is much easier to overcome when interest rates are low. For example, say you make a loan to your child when the AFR is 2%. And he or she invests the funds in a business, real estate or other assets that earn a 7% return. Then the difference between the loan payments and the returns earned by the borrower’s investment is, in effect, a tax-free gift.

Grateful For GRATs

A grantor retained annuity trust (GRAT) is another estate-planning tool that is particularly effective in a low-interest-rate environment. When you establish a GRAT (which is irrevocable), it pays you an annuity (a fixed dollar amount, typically paid annually) during the trust term. After that, the remaining assets are distributed to your children or other beneficiaries.

Here’s the secret to the GRAT’s tax-saving power: Funding the trust is considered a taxable gift to your beneficiaries, but the amount of the gift is based on the projected value of their remainder interests at the end of the trust term. And this value is calculated by assuming that the trust assets will grow at the “Section 7520” rate — a conservative rate of return set monthly by the IRS.

So long as you survive the trust term, any earnings that exceed the Section 7520 rate (at the time the trust is set up) are transferred to the beneficiaries tax-free. Again, this is a fairly easy hurdle to overcome when interest rates are low. In addition, by funding the trust with assets that have declined in value, you can minimize the tax impact even further.

How Does Your Plan Rate?

These are only two examples of estate planning strategies that benefit from low interest rates. There are other possibilities. We can help you identify strategies that are appropriate for your financial situation and goals.

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