Low interest rates drive succession planning opportunities
Timing can be very important to estate planning. Ironically, this is an update of a column we wrote just after the events of Sept. 11, 2001, which led to an extended time of economic uncertainty. In the months following, the Federal Reserve lowered short-term interest rates to levels not seen in more than 30 years.
But today, rates are far lower than they were then.
When interest rates are low, everyone knows that it may be a good time to take out a loan or refinance a home. Low rates also have a positive effect on some estate planning techniques, particularly in the area of succession planning.
Most important, for estate planning, the IRC 7520 rate — the interest rate the IRS assumes that you can earn — has been at historic lows for several months now. It sits at just 2 percent for the month of February, compared to a rate of 5.4 percent in January 2002, which then equaled the previous low rates set in November and December of 1998.
With techniques that involve a division of ownership between present interests (e.g. the right to income or an annuity) and future interests (usually the right to receive principal after several years), lower interest rates mean that future interests are worth relatively more while present interests are worth relatively less. When income interests are under-valued, techniques like Grantor Retained Annuity Trusts, Charitable Lead Annuity Trusts, Private Annuities and Installment Sales become more attractive.
Meanwhile, the stock market has tumbled, along with the value of most other assets, including real estate and closely held businesses.
Sharply lower prices, together with rock-bottom interest rates, make this an especially good time for many people to shift wealth down to the next generation. Many advanced estate planning strategies are based on the assumption that property, such as stocks, real estate and business interests, will be worth more in the future.
Basic gift techniques to consider
Current law permits you to use the $13,000 annual exclusion — up from $12,000 in 2008 — to give that amount to as many people as you wish, each year, without any tax consequences and without even having to report it to the IRS. These can be especially attractive if made with assets at temporarily depressed prices.
Given the stock market meltdown and the economic downturn in Michigan, simple gifts of marketable securities or fractional interests in a family business, family partnership or limited liability company can be more effective this year.
For example, if you give 1,000 shares of stock trading at $13 a share — a $13,000 gift — this year, and the stock bounces back to its previous price of $40 a share, you've essentially tripled the value of your gift and the post-transfer appreciation will escape transfer tax.
Low interest rate loans
A low interest rate loan can be a tax-smart strategy. Unusually low rates allow lenders to charge less to family members and to shelter the potential growth of valuable assets. The IRS sets minimum rates for loans between family members. For February 2009, those rates range from just 0.60 percent to 2.96 percent, depending on the term of the loan.
If you are concerned that your family member doesn't have the wherewithal to repay the loan, then consider making the low-interest loan but forgiving part of that loan principal each year through the annual gift-tax exclusion. Together, a couple could forgive $26,000 of loans each year to as many individuals as they wish.
Freeze strategies benefit from lower interest rates
A Grantor Retained Annuity Trust works particularly well with a valuable asset, such as a family business or beaten down stock that you expect to increase sharply in value in coming years. A GRAT can help you pass on most of that increased value to your heirs tax-free.
To establish a GRAT, you put assets into a trust for a term of years, which can be as few as two, and name your children (or a trust for their benefit) as beneficiaries. You then receive annuity payments from the trust with a value equal to what you put into the trust, plus an IRS assumed rate of return.
In valuing a gift made in February 2009, the IRS assumes the asset will return just 2 percent annually. If the actual performance of the asset is better, then most of the appreciation can pass to your descendants transfer tax-free when the trust expires.
Under current law, the federal estate-tax exemption amount for 2009 is $3,500,000, and the tax rate on the value of an estate in excess of that amount is 45 percent. Absent new legislation, the tax is scheduled to disappear entirely in 2010, only to reappear in 2011. As of Jan. 1, 2011, only the first $1,000,000 of a decedent's assets would be insulated from transfer tax, and the maximum transfer tax rate would be 55 percent, with a 5 percent surtax.
Virtually no one expects the scheduled estate tax repeal in 2010 will occur. That means the classic advantage of giving away appreciating assets sooner rather than later is as relevant as ever. There are also a number of rumors circulating that Congress may soon take action, as part of a major estate tax overhaul, that would eliminate valuation discounts or make GRATs less attractive.
Pamela Tyler is an estate planning partner in the Varnum law firm.