Economic Downturn Plus Low Interest Rates Equals An Excellent Opportunity for Estate Planning

1. Review Your Plan

Before getting into advanced estate plan strategies, for clients with existing estate plans, now is a great time to review your plan and make sure it reflects your wishes.  Specifically, reviewing your fiduciaries and dispositive provisions in your estate plan documents and updating Powers of Attorney should be completed.  Keeping these foundational documents up to date grants you and your loved one’s peace of mind in the event the unthinkable happens.

2. Current Tax Environment

The current estate, lifetime gift, and generation-skipping transfer tax exemption is higher than it has ever been, being $11.58 million per person under current law.  Estates in excess of the exemption amount can be taxed at rates exceeding 40%.  This high exemption amount (increased annually for inflation) will remain in effect until the sooner of 2026 or an intervening change by Congress.   Under current law, though, the exemption amount decreases to approximately $5 million per person in 2026.  Therefore, there is a use it or lose scenario with the current exemption.  Using the current exemption during lifetime can be beneficial for income taxes, estate taxes, creditor protection and generational planning.

3. Take Advantage of Low Interest Rates

While estate tax exemption amounts at a historic high, interest rates are at a historic low.  Interest rates are the fuel for advanced estate planning and when the rates are as low as they are now, the current interest rates are equivalent to jet fuel for estate planning.  Given these low federal interest rates, the higher estate exemption amounts and the long-term positive outlook for marketable securities and private ownership interests, now is an excellent time to consider advanced estate planning opportunities.

4. Family Limited Liability Company

In a low interest rate environment, estate plan strategies often involve implementing one or more transfer strategies that leverage the low interest rates in order to transfer wealth with little or no gift tax.  Oftentimes, a business entity such as a LLC will be involved.   There are many benefits of using an LLC in your advanced estate planning.  Those benefits, include the following: (i) minimizing gift tax liability for gifts of LLC interest; (ii) gifts or sales may be at discounted values because of the restrictive nature of LLC interests, so gift or sale price is locked in at a value less than the value of the underlying assets gifted or sold; (iii) protecting the assets from creditors; (iv) providing economies of scale in family investing; (v) involving the family in the decision making process of the family’s assets; and (vi) as a training tool to the younger generation for how to manage money.  As an example of the discounting benefits, and assuming a 25% discount, if you were to gift or sell $1M worth of LLC interests to a trust set up for the family, it would represent approximately $1.35M of underlying assets.

5. Installment sale to a Family Grantor Trust (IDGT)

After an LLC is created and funded, a new Family Trust can also be created for the benefit of the grantor’s spouse, descendants or others.  LLC interests may then be gifted or sold at a discounted value to the Family Trust.  By transferring the membership interests to the Family Trust now, the value of any portion of the LLC gifted or sold is locked and all future appreciation on the transferred interests can be out of the grantor’s estate (and future descendants’ estates) for estate tax purposes.  The assets in the Family Trust will also have a layer of creditor protection.  There will not be any income realized on the sale, the grantor can continue to reduce his/her estate by paying the trust’s income tax and the assets in the trust outside of the grantor’s estate can grow essentially income tax and estate tax free.  The tax benefits of this transaction are supercharged as a result of the current low interest rate environment.

6. Grantor Retained Annuity Trust (GRAT)

The grantor retained annuity trust (“GRAT”) is another excellent estate planning option in a low interest environment.  A GRAT permits the grantor to make a gift to a separate trust, the grantor will retain an annuity on the gifted assets and any appreciation over the value of the annuity and the current interest rate can pass to the beneficiaries gift tax free.  Additionally, creditors may not be able to reach the underlying GRAT principal.   GRATs generally are beneficial when the federal applicable interest rate is low, as it is in the current financial climate, because it increases the likelihood of more value being transferred gift and estate tax free.  Individuals often create a series of short-term, rolling GRATs (the grantor funds a new GRAT each year with the annuity from the previous GRAT) rather than a single, longer-term GRAT, to increase the wealth transfer benefits and capitalize on market volatility.

7. Private Annuity

A private annuity is similar in nature to the GRAT.  The private annuity permits the grantor to sell selected assets to a trust established for the benefit of spouse, descendants or other individuals in exchange for the trust’s unsecured promise to make specific, periodic payments to the grantor during lifetime.  This strategy can have the effect of removing a significant amount of assets from the grantor’s estate, while simultaneously providing the grantor with a continuing source of income.  There would not be any gain realized on the initial transaction and the assets sold will be protected from creditors.

8. Charitable Lead Annuity Trust (CLT)

The current pandemic has also put a new emphasis on charitable giving as many not-for-profits are struggling with the economic downturn.  To that end, new law has increased the ability to maximize charitable deductions.  The charitable lead annuity trust (“CLAT”) is a useful technique that when interest rates are low can provide for charitable initiatives and also allow wealth to be transferred to non-charitable remainder beneficiaries. The CLAT is similar to a GRAT, except a charity, not the grantor, receives the annuity.  At the end of the term, the appreciation in the value of the CLAT property in excess of the current interest rate passes to the CLAT beneficiaries free of federal estate or gift tax.

HMB Legal Counsel will continue to provide updates as the situation evolves. The ongoing issues related to the spread of the Coronavirus (COVID-19) have had and will continue to have a significant impact on individuals, families, businesses and markets. Visit our collection of resources providing guidance during these fast-changing circumstances. Please reach out to your lead team member to answer specific questions.