Financial Advice for Retirement, Social Security, IRAs and Estate Planning

How Markets Affect Estate Plans

Published on: Jun 01 2008
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In our visits the last couple of months we discussed how declining asset markets and interest rates affect estate planning. Since then, treasury interest rates appear to have hit a bottom. It is time to look at a few strategies that will produce greater tax benefits when interest rates are higher.

Some estate planning strategies are interest-rate sensitive because treasury interest rates are used to determine the tax costs and benefits. The IRS publishes rates each month, known as the “7520 rates” after the tax code section that mandates them or safe harbor rates, and they are based on current treasury debt rates. Strategies involving trusts and “split interest” gifts are the ones most commonly affected by interest rates.

In the last few months we explained how gifts of property are best made when market prices are low. Also grantor retained annuity trusts and low interest loans receive maximize tax benefits when interest rates are low.

Another strategy worth considering while rates still are relatively low is the charitable lead annuity trust. In this strategy, the estate owner puts property in a trust, which pays annual income to a charity for a period of years. After the term of years ends, the property remaining in the trust goes to heirs designated by the estate owner.

The gift taxes for the remainder that goes to the heirs are paid when the trust is created based on the present value of the property the heirs will receive. The lower interest rates are, the lower the present value of the gift will be. If the trust’s returns are greater than the interest rate, the trust will be worth more than estimated and the excess value passes to the heirs free of estate and gift taxes.

A strategy that has more value when rates are high is the qualified personal residence trust. We discussed the QPRT in the April 2008 visit, because declining home prices mean gift taxes are lower. Higher interest rates also reduce gift taxes on the creation of a QPRT.

In a QPRT, a parent creates a trust and transfers ownership of a residence to the trust. The parent lives in the home and continues to act as owner for a period of years. When the period ends, ownership of the home passes to the children, and the home is out of the parent’s estate.

The higher interest rates are when the trust is created, the lower the gift taxes will be. The longer the parent will live in the home, the lower the gift taxes will be. If the parent dies before the trust term ends, however, the home remains in the estate as though the trust were not created. More details about QPRTs are in the April issue and are in the Archive of the members’ section of the web site.

Another strategy that has the best benefits with higher interest rates is the charitable remainder annuity trust. We discussed the benefits and traps in this strategy in last month’s visit. If rates continue to rise in the coming months, CRATs will be more attractive than they are today.

In a CRAT, a trust is created and funded with appreciated property. The trust pays income to the trust creator (or other designated beneficiary) for life or a period of years. Then, a charity or charities named in the trust agreement receive the remaining trust property. Because the trust is charitable, when property is transferred to the trust the creator receives a tax deduction of the present value of the charity’s remainder interest. The higher interest rates are, the higher the present value will be. Also, the trust creator does not have to recognize capital gains on the appreciation in the property transferred to the trust. Another benefit is the trust can sell the property and also not have to pay taxes on the capital gains, since it is a charitable trust.

In last month’s visit we also raised some caveats about CRATS (and the related charitable remainder unitrusts). These trusts are powerful because of their triple tax benefits. But they are not appropriate for everyone or for every type of property. Trust terms must be selected carefully.

Some strategies are not affected by interest rate fluctuations. Two of them are charitable remainder unitrusts and grantor retained unitrusts. In the previous article in this month’s visit we discussed the differences between annuity trusts and unitrusts. Those factors should be weighed more heavily than the effects of interest rates.

Changes in interest rates can change the attractiveness and benefits of an estate planning strategy into an advantageous one. Rates changes should affect the timing of when a strategy is implemented.

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