Bad For Your Portfolio; Good for Estate Planning
For most of us, investment performance is not what it used to be. Stock yields are dismal, interest rates inch closer to zero, and consistent capital appreciation seems to be a thing of the past. But never you worry. In the midst of the economic doom and gloom lies a golden opportunity.
If your goal is to move wealth to lower generations at the least estate tax or gift tax cost, there has never been a better time. The current reduction in asset values itself provides an opportunity — lower values means lower tax. But our historically low interest rates can compound that opportunity. Put simply, many estate planning techniques work much better in a low interest environment.
Today’s official IRS interest rates are spectacularly low and that can produce significant opportunities. The official short term rate for intra—family loans or sales is an almost insignificant 0.41%. Let’s take a very simplistic example. Assume I loan $10M to a trust for my children at that 0.41% rate. Assume the trust purchases a high yielding asset (there are still a few of those around). All of the yield in excess of the 0.41% will escape estate and gift taxation. Alternatively, if my goal is simply to allow my children to enjoy some of their inheritance while I am still alive, the simplistic loan allows me to transfer significant wealth to them without current gift taxation and the only cost is that very nominal 0.41% interest rate. If I want to lock—in a favorable IRS rate for many years, I can enter into a long term loan or installment sale at the current IRS long term rate of 3.32% (higher than the short term rate, but historically still a bargain).
When the advantage of the low official rates is applied to more complex planning tools, a much greater benefit can result. Many of the traditional planning techniques perform substantially better with low interest rates (although some techniques actually fair worse with low rates). Consider the Charitable Lead Annuity Trust (CLAT). Under that technique, assets are transferred to a trust which pays one or more charities (perhaps your own private foundation) a fixed annuity for a specified number of years or for the duration of a named person’s life. At the expiration of the annuity period, the remaining principal is transferred to your children or to trusts for their benefit. That technique can provide you with a significant charitable deduction, and also allow a major portion of the assets to eventually pass to your children fee of tax. Today, that technique provides nearly three times the benefit as compared to the results achievable under the higher interest rates of only a few years ago.
The Grantor Retained Annuity Trust (GRAT) is another popular tool to transfer wealth with little or no gift tax cost. Under that technique I transfer cash or other assets to a trust which pays me an annuity for a specified number of years or for life. At the expiration of the annuity period, the remaining assets pass to my children or to trusts for their benefit. All other factors being equal, a GRAT established under today’s interest rates will permit several times the amount of assets to pass tax free as compared to GRATs established a few years ago.
Other techniques that are enhanced by lower interest rates are Private Annuities (PAs) and Self Cancelling Installment Notes (SCINs). In the case of a PA, assets are sold to a trust in exchange for a lifetime annuity. A SCIN is a technique where you sell assets in exchange for a promissory note which is cancelled at the time of your death. The CLATs, GRATs, PAs, SCINs and similar tools all have two things in common: they are well established methods of significantly reducing estate and gift taxes, and they all perform much better during times of low interest rates.
Most economists and investment gurus believe we will eventually return to the investment yields of prior years. In the meantime, don’t miss this unprecedented opportunity to transfer wealth to younger generations at a greatly reduced cost.