Estate Planning Techniques in a Low Interest Rate Environment From Austin Estate Planning Lawyer Liz Nielsen

Estate Planning in a Low Interest Rate Environment by Austin estate planning lawyer

As a result of the recent COVID-19 pandemic, interest rates have continued to fall.  This low interest rate environment can be leveraged by individuals to shift their wealth amongst beneficiaries and minimize tax hits on assets.  Three estate planning techniques that can be particularly effective to reduce estate tax liability in a low interest rate environment are: 1) Grantor Retained Annuity Trust (GRAT), 2) Charitable Lead Annuity Trust (CLAT), and 3) Intrafamily Loans. 

Grantor Retained Annuity Trusts

Grantor Retained Annuity Trusts, or GRATs, are a form of irrevocable trusts which allows a grantor to pass along assets to their family members with little or no gift tax.  GRATs are established for a specified amount of time, and pay the grantor a fixed sum of money, or an annuity, each year.  At the end of the GRAT, the beneficiaries receive all assets remaining in the trust with no transfer tax due. 

By end of the GRAT, the grantor will have received payments equal to the value of the assets at the trust’s creation along with interest at the IRS’s specified rate of return (the 7520 rate, also referred to as the “hurdle rate”).  At the expiration of the trust, the beneficiaries will receive any growth that exceeds the interest rate set by the IRS.  That amount passes to the beneficiaries free of gift tax.

Today, the United States is in a notably low-interest-rate environment, which makes it a great time to consider creating a Grantor Retained Annuity Trust.  When interest rates are low, it becomes more likely that the trust assets will exceed the hurdle rate and that family members will receive larger tax-free gifts at the irrevocable trust’s completion.  GRATs tend to be used by wealthy families who are looking to transfer assets to family members while minimizing gift tax.

Charitable Lead Annuity Trust (CLATs)

Just like Grantor Retained Annuity Trusts, a Charitable Lead Annuity Trust is often used to transfer assets to family members and minimize the taxes charged on the financial gifts.  However, a CLAT is a split-interest trust, and names two types beneficiaries: 1) a charitable lead beneficiary and 2) noncharitable remainder beneficiaries.  While the grantor of a GRAT receives the annual annuity payments throughout the term of the trust, a CLAT’s annual annuity payments are received by a charity.  Additionally, the noncharitable remainder beneficiaries of a CLAT are like the listed beneficiaries of a GRAT, who receive any of the asset growth which exceeds the hurdle rate.

A Charitable Lead Annuity Trust passes along gifts and wealth to a grantor’s beneficiaries in the same manner that a GRAT does.  When the term of the trust ends, all growth of the trust assets exceeding the hurdle rate will be given to their listed noncharitable remainder beneficiaries as tax-free gifts.  In a low-interest-rate environment, beneficiaries are more likely to receive larger gifts without subject to the gift tax rates.  While the CLAT and GRAT serve similar functions, the CLAT can help a grantor achieve their charitable goals, while providing an economical manner to shift wealth to family members or friends.

Intrafamily Loans

The third technique to consider for estate planning in a low-interest rate environment is intrafamily lending.  Just like GRATs and CLATs, an intrafamily loan can be used as a means of transferring wealth to family members without it being subjected to the gift tax.  Some individuals use intrafamily loans to allow their family members to purchase shares of a family property or business.  In a low-interest-rate environment, there is a higher probability that an intrafamily loan can be used to fund an investment, whose return exceeds loan’s interest rate. 

Today’s low-interest rate environment makes it easier for the return on the loan’s investment to exceed the interest rate, while also exempting the wealth or asset redistribution from the gift tax.  While the interest rate will differ based on the length of an intrafamily loan, they should comply with the Applicable Federal Rate.  The Applicable Federal Rate marks the lowest threshold for an interest rate that can be assigned to a loan without the IRS classifying it as a gift.  Still, the Applicable Federal Rate will always be considerably lower than the gift tax.

Next Steps

There are many factors that need to be taken into consideration when considering a tax-motivated gift.  The current low-interest rate environment may bring these options to the forefront, but it is necessary to consider your specific needs before beginning any gifting program.  It is important to discuss your goals and priorities with a qualified estate planning attorney to determine the right strategies for your specific situation and goals.

Contact Us Nielsen Law PLLC provides family focused estate planning to individuals and families in Austin, Round Rock, Cedar Park, and the Central Texas area.  For more information and to learn about our firm, please contact us.