When interest rates are historically low, as they are now, the potential for success of certain estate planning techniques increases. One such technique is a Grantor Retained Annuity Trust (GRAT).
A GRAT is an estate planning tool that allows an individual to transfer interests in appreciating assets to an irrevocable trust at a lower transfer tax cost and retain an annuity interest for a trust term of a specified number of years. At the end of this trust term, the property remaining passes to the remainder beneficiaries of the trust. Because of the retained annuity interest, the value of the gift is “discounted”.
To illustrate, assume that a 60-year old individual transfers $1,000,000 to a GRAT and retains a 10% annuity for 10 years. The value of the gift of the remainder interest is approximately $120,000. Generally, a GRAT succeeds (that is, property remains in the trust for benefit of the remainder beneficiaries) when the investment return on the property exceeds the IRS established interest rate for valuing the annuity. The IRS established interest rate for March of 2009 is 2.4%. Therefore, if the investments perform at a rate greater than 2.4%, the GRAT is likely to succeed as a wealth transfer tool. Thus, in the example above, if the principal in the GRAT grows at 5% per year, there will be $371,000 for the remainder beneficiaries at the end of 10 years. As a result, in this example the remainder beneficiary will receive $371,000 even though the gift tax was based on a gift of only $120,000.
A GRAT also can be structured with virtually no taxable gift. This technique is referred to as a “zeroed-out GRAT”. The reason there is no taxable gift is that the donor’s retained annuity causes the donor to receive back the entire amount contributed to the GRAT, plus interest thereon. Any appreciation on such property above the annuity payments then passes to the remainder beneficiaries of the trust, free of gift tax.
A similar technique that is beneficial in a low interest rate environment for individuals with current charitable giving goals and significant liquidity is a charitable lead annuity trust (CLAT). In a CLAT, the annual annuity is distributed to charity, rather than to the donor. The donor receives a gift tax deduction for the value of the interest passing to charity. This deduction reduces the value of the remainder interest passing to the donor's children at the end of the CLAT term.
Another technique often used to take advantage of the lower interest rates is a sale of assets to family members (or an entity or trust comprised of family members) for a promissory note. Capital gains rates currently are still low and may increase in the future. Thus, now is a good time to sell assets and recognize capital gain. In some cases, the sale may even be structured to defer capital gain recognition. Such assets can be sold to family members at fair market value, subject to any appropriate discounts, for an adequate down payment and a promissory note. The IRS established interest rate for March 2009 is 1.94% for loans that remain in place for more than 3 years but not more than 9 years. For loans in excess of 9 years, the March 2009 interest rate is 3.52%. If the assets’ investment return is higher than the IRS established interest rate, the leveraged purchase will result in greater economic value to the trust beneficiaries.