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 specified number of years. At the end of the term, the property remaining passes to the remainder beneficiaries. 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 $230,270. Generally, a GRAT succeeds (that is, property remains for the remainder beneficiaries) when the investment return on the property exceeds the IRS established discount rate for valuing the annuity. The IRS established interest rate for November of 2008 is 3.6%. Therefore, if the investments perform at a rate greater than 3.6%, 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 $230,270.
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 amount is distributed to charity rather than the donor. Because of the annuity amount passing to charity, the remainder interest passing to the donor's children at the end of the CLAT term is reduced for gift tax purposes.
Another technique often used to take advantage of the lower interest rates is a sale of assets to family members (or an entity comprised of family members) for a promissory note. Capital gains rates are likely to increase in 2009. Thus, now is a good time to sell assets and recognize capital gain. 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 November 2008 is 2.97% 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 November 2008 interest rate is 4.24%. 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.