Key takeaways:
What this may mean for you:
This update outlines three estate planning strategies to help take advantage of low interest rates and increased estate exemptions. Changes in tax legislation could reduce or eliminate many of the benefits described below. Please consult your estate and tax advisor before proceeding with any of the strategies explained below.
Are you planning to transfer any assets in the future?
Each month, the IRS publishes an applicable federal rate (AFR) that can be used for personal intra-family loans, as well as certain related discount rates that may be used for present value computations that apply to a variety of estate planning strategies. Both the AFRs and the discount rates can impact the related calculations and the effectiveness of the strategies. Three wealth transfer techniques — grantor retained annuity trusts (GRATs), charitable lead trusts (CLTs), and loan-based solutions — can be more effective when rates are low.
In a low interest rate environment, investors have a low hurdle rate to overcome in order to transfer surplus wealth to their beneficiaries. If markets are favorable and you achieve a total return greater than the hurdle rate over the term of the trust, the value transferred to the beneficiaries could be greater than the amount initially transferred and reported as a gift.
Additionally, the low AFRs may allow you to act as a lender and charge a lower interest rate to your beneficiaries to transfer wealth at a more efficient rate. A rise in federal interest rates will increase the linked IRS hurdle and intra-family lending rates, making GRATs, CLTs, and intra-family loans less advantageous. In 2022, the rates have risen slightly, but the interest rates are still at a very desirable level for wealth transfer purposes.
1. GRAT:
A GRAT is a wealth transfer technique commonly used to transfer assets to a designated beneficiary. This strategy is typically considered successful when the assets placed in a GRAT appreciate at a rate that exceeds the discount rate over the term of the GRAT.
2. CLT:
A CLT is an irrevocable trust that pays a charitable beneficiary an annuity or unitrust amount for a prescribed period of time. Similar to a GRAT, a CLT is linked to the interest rate the IRS set in the month it was funded. Depending on how it was structured, a CLT may provide an income, gift, or estate tax deduction.
3. Loan-based solutions:
Low interest rate environments may be advantageous for personal, intra-family loan-based solutions where you, as the lender, can provide your beneficiaries with loans at the prescribed AFR, which often may be below commercial rates.
With interest rates at historical lows for the past few years and a prediction of steady increases on the horizon, this could be a good time for families with estate tax exposure to evaluate estate planning strategies that benefit from favorable AFR and Section 7520 rates, which are still not far above historic lows. We suggest speaking with your advisor, as well as your tax and legal advisors, about what is most appropriate for your individual and family situation. Please be aware that proposed tax legislation could alter or eliminate many of the benefits described above.
Advice and Planning offered through Wells Fargo Bank, N.A.
Wells Fargo and Company and its Affiliates do not provide tax or legal advice. This communication cannot be relied upon to avoid tax penalties. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed.
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