by Alisa Kim O’Neil, JD, CTFA, AEP®, CDFA®, Director of Estate & Financial Planning
With the current low interest rate and AFR (Applicable Federal Rate)* environment, it is a good time to incorporate these rates to update your estate plan. Below are a few of the strategies for you to consider.
Grantor Retained Annuity Trust (“GRAT”)
An irrevocable trust created and funded by the Grantor in which she/he retains a fixed dollar amount annuity for a set number of years (“GRAT term”). At the end of the GRAT term, the remaining balance of the trust is distributed to the designated beneficiaries (outright to named individuals or to a remainder irrevocable trust) estate tax free.
The IRS does not look at the growth of the assets when taxing the trust for gift tax purposes. It only looks at the value of the gift of the remainder interest. Therefore, the Grantor can gift the growth in the balance of the trust while using a minimal amount of lifetime exemption.
Grantor pays all the income taxes on the income generated from the trust, resulting in a further gift to the remainder beneficiaries of the trust who benefit from the growth of the trust without incurring income taxes.
An Installment Note to an Intentionally Defective Grantor Trust (“IDGT”)
An IDGT is called such because it is an irrevocable transfer of assets to a trust that holds assets which are excluded from the Grantor’s estate. However, the Grantor is still the payor of the income taxes due by the trust during his/her lifetime. By retaining the income tax liability of the trust during the Grantor’s lifetime or for a time certain, the Grantor can make an additional gift of the income taxes to the trust.
The Grantor would sell the asset to the IDGT while taking back a promissory note with interest payable at the current low AFR. The rate of return on the asset now owed by the IDGT will be higher than the interest rate owed on the note. This results in a tax-free transfer to the trust.
Charitable Lead Annuity Trust (“CLAT”)
Like a GRAT, this trust pays out an annuity for a term of years and then the balance is paid out to named remainder beneficiaries. In this case, the recipient of the annuity is a charity. The term charity for CLAT purposes includes a Donor Advised Fund or a Private Foundation. At the end of the CLAT term, the balance is paid to a non-charitable beneficiary, other than the Grantor. The beneficiary can be an individual or a trust.
The taxpayer receives the income tax deduction in the year that the CLAT is established and funded. the IRS assumes that the assets will grow at the stated rate at the CLAT funding, since it is a low interest rate environment, the actual growth should be much higher.
Intra Family Loans – New and Refinancing Existing
Family members can make loans to one another at a lower interest rate (the AFR rate) between each other. The AFR rate is significantly lower than the average 30-year mortgage. Additionally, the lender can forgive the annual interest of up to the annual exlusion amount, thereby making an additional gift to the borrower.
Note: For those clients who already have an intra family loan, this may be a good time to refinance the loan to a lower interest rate.
Additional steps to consider:
- The CARES Act allows those individuals in pay status to suspend their 2020 minimum required distribution (“MRD”).
- Refinancing your mortgage – in this low interest rate environment, clients should consider refinancing their existing mortgage to a lower rate.
- Due to the current bear market environment, taxpayers who find themselves in a lower income tax bracket should consider doing a Roth conversion of a portion of their IRA assets.
- This is also a good time to review your incapacity documents, estate planning documents and beneficiary designation forms.
*Each month, the IRS publishes short-, mid- and long-term rates (the Applicable Federal Rates, or AFRs) and the §7520 rate. The AFRs reflect the minimum interest rate that must be charged for loans between related parties; the §7520 rate, which is 120% of the mid-term AFR, is used to calculate annual payments for certain estate planning techniques including GRATs and CLATs. https://www.irs.gov/pub/irs-drop/rr-20-09.pdf
Please remember that you should always consult with your tax preparer and estate planning attorney regarding your specific tax situation. If you have any questions, please contact a member of our Estate and Financial Planning Group:
Alisa Kim O’Neil – [email protected] or 617-275-0313
Kathy Sablone – [email protected] or 617-956-9712
Important: This article does not contain any legal or tax advice. You should always consult with your attorney, accountant or other professional advisors before changing or implementing any tax, investment or estate planning strategy.
IRS Circular 230 Disclosure: Pursuant to IRS Regulations, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.