Today's historically low interest rates, coupled with depressed asset values due to the current market crisis, may make this an excellent time for advisors to engage in various estate planning techniques. Minimizing gift and estate tax when transferring assets is of primary importance in this uncertain time, and current conditions present several opportunities for transferring wealth at little or no gift tax cost. The following summary highlights several estate planning techniques that could provide significant tax advantages in a low interest rate and depressed asset value environment.
Private annuities: In a typical private annuity transaction, a parent transfers property to a child in return for that child's unsecured promise to pay the parent a fixed income for life. If the fair market value of the property transferred equals the present value of the annuity under the IRC Section 7520 tables, there is no gift tax on the transfer. A decrease in the interest rate lowers the annual payment amount that the younger family member has to make to the older family member, thereby increasing the benefit of the private annuity as a wealth-transfer technique.
Grantor retained annuity trust (GRAT): A grantor transfers property to an irrevocable trust and retains an annuity interest for a specific term. At the expiration of the term interest, the property typically passes to a child or other named individual. Gift tax is payable on the present value of the remainder interest (i.e., the full value of the property placed in trust less the value of the retained interest). As interest rates drop, the value of the retained interest increases, thereby decreasing the value of the gift of the remainder interest.
Charitable lead annuity trust (CLAT): A CLAT is an irrevocable trust that pays a charitable beneficiary an annuity interest for a specific term (which may be measured by one or more lives). At the expiration of the charity's term interest, the property typically passes to the children or grandchildren of the donor. A decrease in interest rates increases the gift or estate tax deduction for the annuity interest going to the charity and decreases the value of the gift of the remainder interest.
A remainder interest in a residence or farm: A donor can retain a life interest in a residence or farm and give the remainder interest to charity. A decrease in the interest rate increases the charitable deduction available for the remainder interest in the farm or residence given to charity.
Advisors should also be aware of certain strategies that are actually rendered ineffective in an environment of falling interest rates. Two examples are qualified personal residence trusts (QPRTs) and charitable remainder annuity trusts (CRATs).
Qualified personal residence trust (QPRT): A QPRT is an irrevocable trust to which a donor transfers his or her personal residence and retains the right to reside in the residence for a specific term of years. After the term of years, the residence passes to the children or other named beneficiaries. A decrease in the interest rate lowers the value of the retained interest and increases the value of the gift of the remainder interest in the residence.
Charitable remainder annuity trust (CRAT): A CRAT is an irrevocable trust in which the donor retains an annuity interest, typically for himself or herself. After the end of the annuity term (measured by an annuitant's lifetime or a term of years), the remaining property in the CRAT passes to a named charity. A decrease in interest rates produces a smaller income, gift and estate tax charitable deduction. It also increases the value of the gift of the annuity interest when the retained annuity interest is given to someone other than the donor (such as a child or grandchild).
Finally, it is important to recognize that interest rates do not significantly impact all estate planning strategies. For example, three types of unitrusts -- charitable remainder, grantor retained and charitable lead unitrusts -- are essentially unaffected by interest rate fluctuations.
Charitable remainder unitrust (CRUT): A CRUT is like a CRAT, except the retained interest is measured by a "unitrust" amount (i.e., an amount calculated as a percentage of the current trust balance) and not an annuity amount (i.e., a fixed dollar amount). Changes in interest rates do not impact the income tax deduction or gift tax costs of a CRUT.
Grantor retained unitrust (GRUT): A GRUT is like a GRAT, except the retained interest is measured by a "unitrust" amount and not an annuity amount. As the trust value fluctuates, the amount of the unitrust payment will change. Changes in interest rates equally impact the interests of both the unitrust beneficiary and the remainder beneficiary.
Charitable lead unitrust (CLUT): A CLUT is like a CLAT, except the charity's interest is measured by a "unitrust" amount and not an annuity amount. Estate and gift tax factors are essentially unaffected by changes in the interest rate.
Although it may be difficult for clients to part with wealth in these uncertain times, taking advantage of the estate planning opportunities described in this article may prove to be an effective strategy that could benefit both your clients and their heirs for many years to come.
As required by the IRS, you are advised that any discussion of tax issues in this material is not intended or written to be used, and cannot be used, (a) to avoid penalties imposed under the Internal Revenue Code, or (b) to promote, market or recommend to another party any transaction or matter addressed herein.
Jackson and its affiliates do not provide legal, tax, or estate-planning advice. For questions about a specific situation, please consult a qualified advisor.
The opinions expressed in this article are those of Jason Ryan and not necessarily those of Jackson National Life Distributors LLC.
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