Today interest rates are still quite low, but the Federal Reserve just hiked rates for the first time since the financial meltdown of 2008. Interest rate increases impact estate plans in a number of ways. With low interest rates, intra-family loans are very advantageous because the total amount of interest to be repaid is less. Similarly, the hurdle rates for Grantor Retained Annuity Trusts (GRAT) are lower and sales of assets to Grantor Trusts are less expensive. In a rising interest rate environment, it pays to act promptly. A delay implementing these strategies could wind up costing thousands of additional dollars unnecessarily or completely upend the purpose of the transaction.
Here are some examples of how waiting to implement certain estate planning strategies can be detrimental. Intra-family loans commonly done by people of all economic levels. Generally, mom and dad loan money to younger generations to buy a house, a business or maybe even for college. Many people simply make interest free loans. However, technically this is not permitted by the IRS. If the IRS takes a closer look at this type of transaction, it will impute interest at the current prevailing rate and call the amount a taxable gift. To avoid this you should document your intra-family loans with a promissory note that bears a reasonable interest rate. That is to say an interest rate that matches or just slightly exceeds the prevailing rate. Currently, these rates are between 2% to 3%. If rates rise you can see how it would become much more difficult for a child to repay the loan.
Another strategy I love is the sale of an asset to a grantor trust. This is often a good way to remove a significant appreciating asset from your estate while locking in a long term stream of income. In general, the strategy works as follows: 1) set up a grantor trust, usually for children and more remote descendants; 2) seed the trust with certain assets (generally cash), then 3) enter into a purchase and sale transaction between yourself and the trust. The trustee will often purchase the assets with a down payment of the initial seed money together with a promissory note. Because this is a grantor trust, the transaction is tax-free. As you can imagine, the lower the interest rate the easier it will be for the trust to repay the loan. This plan works great for dealing with a business or investment real estate.
GRATs are somewhat similar to the sale to grantor trust, however, you make a give of the asset instead of a sale. In return you get annuity payments from the GRAT. The annuity payments are a function of the value of the asset and current interest rates. Any excess return over and above the annuity amount is passed on to heirs, free of gift and estate taxes. Again the higher the interest rate, the harder it is to pass wealth to heirs. There are other strategies as well, however, all work best in a low interest rate environment and not so well in a high interest rate environment. So do not delay. Make the most of these wealth shifting opportunities by setting one or more up now, while rates are still low.
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