There are a number of estate planning strategies that work well to move assets in an efficient manner from one generation to another within a family. In evaluating any such strategy, one must consider the goals of the family, the underlying assets of the family and gift, estate, generation-skipping and income tax issues. In the current, historically low interest rate environment, the particular estate planning strategies listed below work particularly well and should be considered:
- Grantor Retained Annuity Trusts (GRATs). A GRAT is an irrevocable trust created by a grantor who transfers assets to an irrevocable trust for a selected term of years. A GRAT creates an annuity to be paid to the grantor over the course of the trust term. Such annuity is typically equal to the value of the property transferred to the GRAT, plus an annual interest component (the “hurdle rate”) set at the time of the creation/funding of the GRAT. Such hurdle rate is revised monthly. The hurdle rate for GRATs created in October, 2017 is 2.2 percent. This rate is very low relative to historical rates. If the assets in the GRAT outperform the 2.2% hurdle rate during the term, any assets remaining in the GRAT at the end of the GRAT term will pass to the grantor’s children or trusts for the grantor’s children gift and estate tax free. GRATs are grantor trusts for income tax purposes so that the annuity payments back to the grantor do not trigger any additional income or transfer tax. The annuity in a GRAT may also be structured so that it increases up to 20 percent per year which can allow the GRAT assets to remain in the GRAT for a longer period of appreciation. If the assets in a GRAT fail to produce a total return in excess of the hurdle rate, the assets transferred to the GRAT by the grantor will simply be returned to the transferor. Since GRATs are typically structured so that only a very small gift is made upon creation (in order to trigger a three year statute of limitations), if the GRAT assets are returned to the grantor, the grantor is returned to the same position that he or she would have been in but for the GRAT. GRATs can be funded with assets that may be entitled to discounts for lack of marketability or lack of control and that can make them even more effective. Pre-liquidation/IPO assets can be good GRAT candidates. GRATs also work well for grantors who have used their lifetime gift tax exemptions.
- Charitable Lead Annity Trusts (CLAT). CLATs are analogous to GRATs, except that rather than paying an annual annuity to the grantor, a CLAT pays an annual annuity to one or more qualified charities during an initial term. At the end of the initial term, any assets remaining in the CLAT pass to remainder beneficiaries (typically children or grandchildren or trusts for children or grandchildren of the grantor). Like GRATs, CLATs work well for appreciating assets and are most efficient in low interest rate environments. The hurdle rate for CLATs created in October, 2017 is 2.2 percent per year. Clients can use a CLAT to provide funding to a donor advised fund or one or more favorite charities. CLATs are often structured so that the initial funding results in no gift or very little gift on creation.
- Intra-Family Loans. Intra-family loans can be made by a grantor at what is called the “applicable federal rate” or AFR. The AFR rates are announced monthly by the Treasury Department. The rates are currently quite low and thus many individuals make loans to children or grandchildren at the AFR rates. Sometimes the recipient of the loan invests the loan proceeds at a return rate that exceeds the interest rate. Such loans can be forgiven during the lifetime of the donor.
Any or all of these might be useful in taking advantage of historically low interest rates when planning your own estate. Be sure to consult a qualified estate planning attorney about these possibilities.
Jim Flaggert is the Chair of DWT’s Trusts and Estates practice. He focuses on estate planning, administration of trusts and estates, business-succession planning, charitable planning, and estate and trust disputes. He creates charitable trusts and foundations and limited liability companies and partnerships, and assists in creating and funding insurance trusts and qualified personal residence trusts. Jim assists clients with generation-skipping transfer tax planning, and with grantor retained annuity trusts, intentionally defective grantor trusts, and dynasty trusts. Contact Jim at JimFlaggert@dwt. Or directly at 206.757.8044.