Keep an eye on interest rates as you consider your wealth transfer strategies.

  • Interest rates are a key component of wealth transfer strategies, and any changes in the rates will affect these strategies.
  • Some strategies are particularly beneficial in a low interest rate environment, while others become more suitable as rates continue to rise.
  • Until rates rise significantly, the tipping point for changing to high-rate wealth transfer strategies is in the distant horizon.

The Federal Reserve recently raised the interest rate and is expected to continue raising rates. Interest rates are a key component of wealth transfer strategies, and any changes in the rates will affect these strategies. In a low interest rate environment, there are certain strategies that are particularly attractive; however, different methods will become more suitable as the rates begin to rise, and financial strategies always require consideration of individual circumstances.

Understanding the rates
There are two interest rates that are particularly important in estate planning. The first is the Applicable Federal Rate (AFR), which is the minimum rate that intrafamily loans must bear to avoid a gift tax. Loans to a related party that don’t bear the AFR are deemed disguised gifts to the extent the stated rate is below the AFR.

The other is the rate mandated in Section 7520 of the Internal Revenue Code (Section 7520 rate) that is used to determine the value of gifts split between the two parties. These rates are currently at or near historic lows. 

Planning in a low interest rate environment 

There is still sufficient time to utilize the current strategies that are effective in low interest rate environments because, as mentioned earlier, current interest rates still remain near record lows. These strategies are particularly attractive for transferring assets that have the greatest potential for appreciation, and include the following:

  • Grantor retained annuity trusts (GRATs)
  • Charitable lead annuity trusts (CLATs)
  • Intrafamily loans
  • Installment sales to grantor trusts

Strategies to consider when rates begin to rise
While interest rates need to rise significantly before the above strategies fall out of favor or at least become less beneficial, there are other strategies that become more attractive as interest rates begin to rise. Those strategies include:

  • Charitable remainder annuity trusts (CRATs)
  • Qualified personal residence trusts (QPRTs)

What’s on the interest rate horizon?
Interest rates need to rise significantly before GRATs, CLATs, and intrafamily loans fall out of favor. As a result, the economics of these strategies are only slightly less beneficial than in the past few years. Some strategies such as the CRAT and QPRT discussed above will become more attractive as interest rates rise. 

Until the rates rise significantly, the tipping point for changing to high-rate wealth transfer strategies is in the distant horizon. Slowly rising interest rates means the decision should be when to implement the low interest rates strategies rather than discarding them altogether.

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Please see important disclosures at the end of the article.

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