With massive changes happening on a day-to-day and even hour-by-hour basis around the globe, no doubt uppermost in your mind are the health and safety of you and your loved ones. One way to ensure that they are taken care of is to review your current estate plan and update it if necessary.
Basic Estate Planning
At the very least, you should verify that your basic estate planning documents (will, revocable trust, durable power of attorney and advance healthcare directive) are in order and that they accurately reflect your wishes upon your death. If you have minor children, you should confirm that you have nominated appropriate guardians for them. Once the basics are in order, you may wish to consider other steps you may take to provide for your family members.
Gifting
If you have been considering making gifts to family members, now is a particularly good time to do so. As everyone knows, asset values are generally depressed right now, and when the market rebounds (and it will), all that post-gift appreciation will pass to your beneficiaries with little to no transfer tax consequences.
Another reason to consider making gifts to family members at this time is that the increased gift tax exemption amount of $11.58 million per person (currently available through Dec. 31, 2025, at which point it decreases to $5 million, with an inflation adjustment) may, in fact, decrease substantially by as soon as 2021, depending on the results of the 2020 national election. And if you are not totally comfortable making such a significant gift at this time, the use of a “spousal limited access trust” enables you to get access to trust assets if necessary. There are more complex gift and estate planning techniques that you may wish to consider at this time, either in conjunction with an outright gift, or—if you have already used up your entire gift tax exemption—on their own. The efficiency of these types of gifts increases not only as assets values are temporarily depressed but also as interest rates decrease. Since interest rates are now at historic lows, several exciting estate planning opportunities present themselves:
Grantor Retained Annuity Trusts
A grantor retained annuity trust (GRAT) is an irrevocable trust into which the creator (the grantor) transfers assets and retains the right to receive, at least annually, payment of a fixed dollar amount (an annuity) for a specified term of years (the GRAT term). At the end of the GRAT term, the trust’s remaining assets pass to the designated beneficiaries free of transfer tax.
The IRS assumes that the GRAT assets will grow at a certain rate (the “Internal Revenue Code Section 7520 rate” or “hurdle rate”) that is set at the time the GRAT is created. Any growth in the assets in excess of this rate can be passed to the beneficiaries free of gift and estate taxes. The lower the hurdle rate, the larger the potential tax-free gift. For April 2020, the 7520 rate will be only 1.2% per year and in May 2020, that rate is even lower, at a mere 0.8% per year. Assuming ownership of assets that will generate at least the minimum amount of income needed to make the annuity payments, GRATs should be seriously considered by anyone looking for an effective way to transfer assets to younger generations.
Intrafamily Sales
A grantor may choose to sell property that is expected to appreciate to a trust for beneficiaries in exchange for a promissory note, with interest payable at today’s historically low rates. If the property sold earns a rate of return over time that is higher than the interest payable on the note, that excess represents a tax-free transfer to the trust. The property sold, however, must generate enough income to make the loan payments. In addition, unless the trust has been funded with prior gifts, an initial taxable gift (a “seed gift”), will be required when the trust is created. Assuming that the trust that purchases assets from the grantor is a grantor trust (that is, a trust that is considered to be the grantor for income tax purposes), there are no income tax consequences for the grantor when selling an asset to the trust, or when receiving interest payments on the note from the trust.
Charitable Lead Annuity Trusts
If you have any charitable inclinations, you may want to consider a charitable lead annuity trust (CLAT). As with a GRAT, in a CLAT, the grantor transfers assets to a trust in which a charity is designated to receive an annuity stream for a term of years. At the end of the term of years, the balance of the assets remaining in the trust pass to the grantor’s individual beneficiaries. And as with a GRAT, it is possible to structure a CLAT such that the balance of the trust assets pass to beneficiaries transfer tax-free. The value of the gift, if any, is determined by subtracting the value of the annuity stream the charity receives from the value of the assets at the time the CLAT is funded. The value of the annuity stream passing to the charity is affected by the 7520 rate—the lower the 7520 rate, the higher the present value of the annuity passing to the charity. Depressed values and the low-interest rate environment result in more assets passing to your intended beneficiaries transfer tax-free, while also benefiting your favorite charitable causes.
Intrafamily Loans
Clients who do not wish to incur gift tax liability at this time might consider an intrafamily loan to cover mortgages of family members or for other purposes. In addition to low interest rates, other benefits include having the total interest expense over the life of the loan stay within the family and avoiding administrative costs involved in a purchase, such as closing costs and appraisal fees. Please note that, in order for the loan to be treated as a loan and not recharacterized as a gift, the borrower has to be able to make payments on the note. That said, each year, the lender can forgive part of the loan up to the annual gift tax exclusion amount ($15,000 for 2020) without a gift tax consequence. Loans can be made to individuals or to trusts created for their benefit and, if made to a grantor trust (again, a trust in which the grantor is taxed on the income), interest payments on the loan would have no income tax consequence for the lender. If you have made these loans in the past, now would be a good time to consider refinancing them. The midterm Applicable Federal Rate (which is the lowest rate that can be charged without gift tax consequences), for loans with terms of three to nine years in May 2020 is at a historic low of 0.58%.
Please feel free to reach out to us if you would like to discuss either updating your basic estate planning or any of these (or other) gifting techniques.