Four Wealth Transfer Techniques to Employ in a Low-Rate Environment (And One to Use All The Time)

June 21, 2019

Two interest rates set by the IRS and commonly used in advanced wealth transfer strategies are the applicable federal rate (AFR) and the Section 7520 rate, both of which have experienced significant decline and are close to all-time lows. What does this mean when transferring wealth?  Some wealth transfer strategies may be more efficient in a low-rate environment, while others remain unaffected. Four winners, and one draw are:

1. Grantor Retained Annuity Trust (GRAT).

A GRAT is an irrevocable trust typically funded with growth assets and has a defined term. During the term, the Grantor receives an annual annuity payment that is actuarially calculated to equal the value of the trust principal on the date of funding, plus interest at the §7520 rate. At trust termination, any assets remaining in the GRAT pass to the Grantor’s named beneficiaries with little or no gift tax. 

2. Charitable Lead Annuity Trust (CLAT).

Similar to a GRAT, a CLAT is also typically funded with growth assets and has a defined term. At the end of the trust term, the remainder passes, potentially tax-free, to non-charitable beneficiaries. Unlike a GRAT, a charity, not the Grantor, receives the annuity payment during the term. Depending on the structure of the CLAT, an income tax deduction is available either to the Grantor or the Trust itself. The lower the interest rate, the larger the potential tax-free gift to heirs.

3. Intra-family Loan

This is a loan to a family member or trust at the minimum interest rate (AFR) required to avoid imputed income or gift taxes. Payments are often interest-only with a lump sum principal payment at the end of the term. The low cost of borrowing helps keep money “in the family” whether it’s used for a new home, investing, or for personal use. And, in some instances, interest payments on a family loan will be income tax deductible to the payer. The lower rates are, the bigger the win.

4. Installment Sale to Intentionally Defective Grantor Trust (IDGT).  

Here, the Grantor sells an asset to the IDGT and the IDGT issues a promissory note for the balance due, which includes annual payments of interest back to the Grantor. At the end of the term, the balance of the note can be paid to the Grantor, or refinanced for a longer term. Again, when utilizing this technique, the AFR determines the lowest permissible rate. With a lower interest rate, the sale of a highly appreciating asset may transfer wealth to the trust beneficiaries with lower taxes.

5. Unitrusts.

A unitrust strategy provides for a payment of a fixed percentage of trust assets to the beneficiaries based on a valuation that occurs annually (usually on the first or last day of the calendar year, the trust tax year, or on the anniversary of funding). The beneficiaries may be charitable or non-charitable. Unitrust strategies can be effective in preserving trust principal, since lower market returns will result in a smaller payout, and the unitrust percentage (payout rate) will affect the calculation of any permissible deductions. However, a low rate environment doesn’t help here—unitrust amounts can be established independent of the AFR, and success or failure won’t be affected if it’s high or low. This one’s a draw.


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