Trending
It’s widely expected that when the Federal Reserve meets in September, it will (finally) lower interest, perhaps by as much as 50 basis points.
Anticipation of that rate reduction is already putting a renewed spotlight on a various rate-sensitive asset classes, including bonds, gold, high dividend stocks and real estate, just to name a few. In other words, reactions to anticipated rate cuts are proving predictable and there’s nothing wrong with that. Interest rate adjustments in either direction are typically viewed through the lens of asset class-level impact and nearly all market participants are “guilty” of that.
Proving the value in working with advisors, these financial professionals know that some estate planning strategies are best deployed when interest rates are falling. That’s something to ponder not only because rate cuts appear imminent, but also because tens of thousands of baby boomers are retiring on a daily basis, implying the need for estate planning services is going to steadily increase over time.
In alphabetical order, the lower interest rate estate planning tips to consider are charitable lead trusts (CLTs), grantor retained annuity trusts (GRATs) and intrafamily loans.
Know the Ins and Outs of Loaning to Family
It’s often said when extending a loan to a family member, the lender should be prepared for the reality of the cash really being a gift because it’s unlikely to be repaid in full. However, steps can be taken to ensure repayment to a client that’s extending credit to a family member.
Those include drawing up documents that make clear the loan is fixed-rate with a specific timeline and that the outstanding principal must be payed in full at maturity. A step like that is crucial in helping the lender avoid unwanted tax consequences.
“If you later forgive the loan, the IRS will consider the forgiven balance as a gift that will count against your lifetime exemption. And if you happen to pass away before your family member has repaid the loan, the value of the promissory note will be included in your estate for estate tax purposes,” notes Austin Jarvis of Charles Schwab.
Considering CLTs, GRATs
As the aforementioned acronym indicates, GRATs possess an element of annuities with the payments determined by the IRS' Section 7520 rate. Jarvis notes that GRATs are basically bets on the client living a long life because if there’s still capital left in the GRAT upon the client’s death, it becomes part of the taxable estate.
That’s one element to be taken into account when discussing GRATs. The other – and it’s a big one – is the performance of the assets backstopping the GRAT.
“Because of this, a common approach is to set up a two-year GRAT. Longer terms may be more advantageous, but you should consider your age, health, and other factors when choosing the term of your GRAT. You may incur legal and administrative costs when creating a GRAT,” observes Jarvis.
Regarding CLTs, there are two primary iterations: grantor CLTs and nongrantor CLTs. In the former, the donor is in control of the assets and in the latter, the trust controls the assets. In most cases, the grantor CLT is better deployed for income tax mitigation rather than as an estate planning tool. Nongrantor CLTs have income tax perks, too, including unlimited charitable deductions, and potentially more suitable to a broader swatch of clients.
“Although you as the grantor do not receive a charitable tax deduction for the transferred assets, you may take a gift or estate tax deduction on the present value of the calculated charitable benefit—and you are not responsible for any income taxes on the trust's income during the term,” concludes Jarvis.
Related: Why Cash, Money Markets Make Sense for Some Investors