Some folks may want to take advantage of some wealth-transfer strategies before rates increase further, while keeping other possibilities available in the coming years if rates continue rising from today's low levels. The NASDAQ article, "Estate Planning: How to Adjust to Rising Rates," has two strategies that work best when rates are low—and two to consider if rates keep going up.
Intrafamily Loans. Wealthy individuals occasionally will lend money to their adult children for investment purposes. They also might transfer a promising investment to their children and take back a promissory note on which the children pay interest. Any net investment return above the loan rate is considered a tax-free transfer of wealth to the younger generation. The federal tax regulations stipulate the minimum interest rate parents are required to charge in order to avoid a below-market-rate loan that will be deemed a taxable gift. As rates rise, borrowers will be required a higher rate of return to make a profit, which could make the strategy less inviting. Those that have already used this strategy may think about refinancing to lock in low rates and to extend the term of the loan.
Grantor Retained Annuity Trusts. GRATs are frequently used by wealthy individuals who want to pass down appreciating assets to heirs without incurring a hefty gift tax and to lower their overall estate-tax burden. GRATs are designed for a term of two years or more and are often funded with assets with high growth potential, including private equity. The grantor who creates the GRAT usually receives annuity payments from the trust that add up to the assets original value and a market-based interest rate set by tax rules. If the assets in the GRAT generate a total pretax return that exceeds that hurdle rate, the excess return passes to heirs free of gift and estate taxes. If you believe that the interest rates will continue to rise, set up a new GRAT to lock in today's rate.
Qualified Personal Residence Trusts. This might be more attractive when rates are higher—creating a trust to pass a primary residence or vacation home to heirs. The grantor still has the right to live in the home for a set period. A qualified personal residence trust will freeze the value of the property for gift-tax and estate-tax purposes at the time of creation, and the potentially taxable gift is the present value of the asset in a certain number of years. If rates are higher, the present value of the asset is lower; as a result, the gift value is lower.
Charitable Remainder Annuity Trusts. With a CRAT, you place assets into a trust and name one or more charities as the ultimate beneficiary, but you still draw income during your lifetime. The grantor gets a tax deduction at the time the CRAT is funded for the remainder interest that will ultimately pass to the charity. When interest rates are high, the present value of the income stream the donor receives is lower, so that the value of the gift to the charity is higher for tax purposes. The higher the interest rate at the time a CRAT is funded means the greater the tax deduction.
Meet with an experienced estate planning attorney to determine if these wealth transfer strategies make sense for you and your family.
Reference: NASDAQ (December 23, 2015) "Estate Planning: How to Adjust to Rising Rates"