Regularly reviewing existing estate plans is a good financial practice, and the looming change to the lifetime estate/gift tax exemptions at the end of 2025 makes now an opportune time to review your plans. Two powerful tools in estate planning are time and interest rates. With time, the more you have remaining, the greater the number of estate planning options available to you. With interest rates, the lower the prevailing rates, the more likely investments can achieve excess returns, thus the more attractive many strategies become. The ultra-low interest rates of the past decade were a boon for many estate planning strategies, but the increase in interest rates does not mean the end of effective estate planning opportunities. Indeed, there are a handful of strategies that become even more attractive in a higher interest rate environment.
Rising interest rates influence the effectiveness of various estate planning tools. Leveraging these tools wisely can lead to substantial tax savings and help ensure assets are efficiently transferred.
Below we review some of the most effective estate planning strategies for a high or rising interest rate environment and the particular characteristics that make them attractive.
A QPRT allows individuals to transfer a personal residence (primary or vacation) to their descendants in a tax-efficient manner while retaining the right to live in the residence rent-free for a defined period of time. QPRTs offer several benefits:
CRTs can offer several benefits including providing an income stream, enabling wealth transfer, reducing income taxes, providing tax efficiency to asset growth, and serving philanthropic goals. In its simplest form, a grantor places assets into a CRT and receives an income stream from those assets for the life of the trust. The trust can be designed so this income stream goes to the grantor, their spouse, their descendants, or other beneficiaries. At the end of the CRTs term, all remaining assets are distributed to a charity or charities. Some advantages of a CRT include:
While QPRTs and CRTs benefit from higher interest rates, there are several strategies that, while more beneficial in low interest-rate environments, may still be very effective when higher rates prevail.
A GRAT can be an effective vehicle for transferring assets to the next generation. A GRAT allows a grantor to transfer assets into a GRAT and receive an annuity payment back for the term of the trust (often between two and five years). Assets that are temporarily depressed in value, expected to grow significantly, or that generate high-income are good candidates for funding a GRAT. At the end of the GRAT’s term, and after all annuity payments have been made to the grantor, the beneficiaries get to keep any remaining assets. Depending on how the GRAT is structured, the transfer of assets to the remainder beneficiaries can be free of estate/gift tax.
A GRAT’s annuity payment is based on the IRS’ published Section 7520 rates, which generally track the overall interest rate environment. That rate for November 2023 is 5.6%. If the investment performance of the GRAT exceeds this interest rate, the excess can transfer free of gift taxes. In the event the GRAT’s investment performance does not beat this “hurdle rate,” there is no penalty and the assets simply revert back to the grantor.
Like GRATs, intra-family loans were a popular tool for transferring wealth during the ultra-low interest rate period but may still be worth considering in the current environment. This strategy typically involves a grantor lending money to a next-generation member (often in trust) and allowing them to invest the funds. If the borrower can generate investment returns in excess of the loan payments, the excess accrues to the borrower free of estate/gift taxes.
Despite the rise in interest rates, the required minimum rate on intra-family loans (the Applicable Federal Rate as mandated by the IRS) may still be lower than commercial rates. For example, the minimum interest rate permissible by the IRS for intra-family loans initiated in November 2023 on loans between three and nine years in term is 4.69%. This means assets that may be at temporarily depressed values or expected to appreciate meaningfully could be lent to a borrower and any appreciation above the 4.69% (AFR) interest rate would be transferred free of estate/gift tax.
A common variation on intra-family loans is for a seller (grantor) to sell an asset to a beneficiary using seller financing. If the asset that is sold appreciates at a rate that is higher than the interest rate used for the loan, that excess appreciation accrues to the person or entity that purchased the asset.
Intra-family loans and sales are often structured so that a grantor trust receives the assets rather than an individual. There can be numerous benefits to using a trust—most significantly, if structured properly, the trust’s income taxes can be paid by the grantor rather than the trust itself or the beneficiaries. Known as a “grantor trust,” this type of trust allows the grantor to pay the taxes on income generated by the trust which can help further reduce the grantor’s taxable estate and allow the assets in the trust to grow free of the drag of income taxes.
In summary, intra-family loans and sales allow a grantor to:
Navigating the ever-changing landscape of interest rates and tax law changes demands adaptive and strategic estate planning. High or rising interest rates offer both challenges and opportunities. By leveraging tools such as QPRTs, CRTs, GRATs, and intra-family loans, individuals may be able to transfer assets, minimize taxes, and support their philanthropic goals. The benefits of these strategies listed above are not exhaustive and there are numerous other estate planning tools available. Each individual’s situation is unique and, as some of these strategies involve irrevocable trusts, should be carefully reviewed with their tax and legal advisors prior to implementation. Please do not hesitate to reach out to a member of the Manchester team should you be interested in discussing your situation further.
Disclosures
This material is solely for informational purposes and shall not constitute a recommendation or offer to sell or a solicitation to buy securities. The opinions expressed herein represent the current, good faith views of the author at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented herein has been developed internally and/or obtained from sources believed to be reliable; however, neither the author nor Manchester Capital Management guarantee the accuracy, adequacy or completeness of such information. Predictions, opinions, and other information contained in this article are subject to change continually and without notice of any kind and may no longer be true after any date indicated. Any forward-looking predictions or statements speak only as of the date they are made, and the author and Manchester Capital assume no duty to and do not undertake to update forward-looking predictions or statements. Forward-looking predictions or statements are subject to numerous assumptions, risks and uncertainties, which change over time. Actual results could differ materially from those anticipated in forward- looking predictions or statements. As with any investment, there is the risk of loss.
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