November 3rd, 2020

Three Estate Planning Strategies for a Low Interest Rate Environment

Low interest rates customarily suggest problems with the economy. However, in these low interest rate environments, there are opportunities, especially for individuals who are concerned about the Federal Estate Tax and Federal Gift Tax. Consider these three estate planning strategies when interest rates are low.

Intra Family Loans

One opportunity is the loan of cash at low interest rates in exchange for a legally valid promissory note. You, as the lender, can “freeze” the value of your Estate while your intended heir can use the cash during his or her lifetime to invest and ideally grow the money at a rate that exceeds the interest rate. Your heir will receive the benefit of the appreciation while you receive the benefit of removing that appreciation from your taxable Estate.

Since 1984, federal tax laws require that a minimum interest rate be charged on any loan. The interest rate is known as the Applicable Federal Rate. The IRS releases these rates every month. For November 2020, the rates are some of the lowest ever available. The short-term rate (defined as the rate for a loan with a term of 3 years or less) is 0.13%. The mid-term rate (defined as the rate for a loan with a term that is more than 3 years but not more than 9 years) is 0.39%. The long-term rate (defined as the rate for a loan with a term that is more than 9 years) is 1.17%.

As an example, assume that you loan $100,000 to your child. If you loan the money with a promissory note that states that the funds should be repaid within 3 years, then the interest rate can be as low as 0.13%. Further assume that your child is able to invest that money so that it grows at an annual average rate of 5% during that 3-year term. The result is that your child was able to grow $100,000 into $115,763 (5% annual appreciation), but owes only $100,390 to you. Your child gets to keep $15,373 without it being considered a taxable gift, and you are able to exclude $15,373 that otherwise would have been included in your taxable Estate.

Grantor Retained Annuity Trusts (GRATs)

A more thorough discussion of GRATs can be found here.

As a quick summary, a GRAT would allow you to transfer assets into a unique type of Trust. At the time of transfer, the federal tax laws will assume that the assets will grow at a certain interest rate for purposes of calculating whether a taxable gift has been made. If the payments from the Trust to you result in the actuarial value of the remainder equaling $0, then the actual assets that remain in the Trust can be transferred to the beneficiaries that you designate without it being considered a taxable gift.

The interest rate used for this purpose is commonly known as the Section 7520 Interest Rate. For November 2020, this rate is 0.4%.

Charitable Lead Annuity Trusts (CLATs)

If you have philanthropic goals, you may consider a Charitable Lead Annuity Trust. This is a Trust whereby you transfer assets into a unique Trust, a charity of your choice will receive the annuity payments for a certain term or during your lifetime, and your heirs will receive any remaining balance.

The annuity amount is a percentage of the original value of the assets that you transfer into the Trust. Based upon the Section 7520 Interest Rate that is applicable on the date that you transfer assets into the Trust, you must calculate the value of any remainder interest that will not go to charity. This actuarially calculated remainder interest will be considered a taxable gift. However, to the extent that the assets grow at a rate that exceeds the Section 7520 Interest Rate, the actual amount transferred to your heirs will be larger than the taxable gift that you report.

For example, assume that you establish a CLAT with a $100,000 gift. The CLAT pays 5% ($5,000) a year to a charity for 10 years. At the end of 10 years, the remaining assets will be transferred to your child. If the CLAT is established in November 2020 when the Section 7520 Interest Rate is 0.4%, then your taxable gift is considered to be approximately $51,000. However, if the investment actually grew at a rate of 6%, the Trust will distribute more than $113,000 to your child at the end of the 10-year term. As a result, you will have transferred $62,000 of additional assets that are not reported as a taxable gift.

If you have interest in these low interest estate planning strategies, seek the counsel of your financial planner or estate planning attorney.

Attorney R. Nicholas Nanovic is an Accredited Estate Planner®, serving as chair of Gross McGinley’s Wills, Trusts & Estates team and on the Tax Law team.

The content found in this resource is for informational reference use only and is not considered legal advice. Laws at all levels of government change frequently and the information found here may be or become outdated. It is recommended to consult your attorney for the most up-to-date information regarding current laws and legal matters.