Low Interest Rates Encourage Families to Re-Visit their Estate Plan

Tuesday, October 22, 2019 |

With all the talk revolving around what the Federal Reserve will do at their next meeting, the focus is usually on what action investors should take in their portfolios. Today, we wanted to discuss a means to turn low interest rates to your advantage to reduce estate taxes, specifically, the impact that a well-constructed Grantor Retained Annuity Trust (GRAT) can have on your financial plan.

What is a GRAT?

  • We touched on GRAT’s in a Post from 2018, that discussed how Charitable Remainder Trusts and Donor Advised Funds were good strategies for charitably inclined business owners.
  • It is an irrevocable trust created for a selected period of time. Assets are placed in the trust in exchange for an annual annuity payment. When the trust term expires the beneficiary receives the assets tax-free.
  • A GRAT may be used to freeze the value of a wealthy individual’s large estate by shifting the appreciation on to their heirs. For example, if a person had an asset worth $10 million but expected it to grow to $12 million over the next two years, they could transfer the difference to their children tax-free. Investopedia
  • Further, say someone was beginning to consider selling a property or business, they could transfer a minority interest at a discounted rate to a GRAT and gain immediate leverage.

Using a GRAT During Low Interest Periods

  • The thing that makes GRAT’s advantageous at this time is the “Section 7520 Interest Rate.”
    • The 7520 Rate is determined monthly by the IRS, and is commonly referred to as the “hurdle rate” in reference to GRAT’s.
  • The Hurdle Rate is important because it is the number the rate of return of the assets in the GRAT must exceed in order to be effective. This is why a low 7520 Rate makes a GRAT appealing now.
    • A few hypothetical examples:
      • A 5-year, $5,000,000 GRAT that was formed in January of 2019 (when the 7520 rate was 3.4%) whose principal grows at 7%, would have made annual distributions of $1.1 million to the grantor and $662,500 would have transferred to the beneficiaries tax free.
      • A 5-year, $5,000,000 GRAT that was formed in November of 2019 (when the 7520 rate was 2.0%) whose principal grows at 7% , would have made annual distributions of $1.1 million to the grantor and $912,500 would have transferred to the beneficiaries tax free, approximately a 38% increase

Important Considerations

  • Be sure to consult an Estate Planning Attorney to determine the correct number of years for your GRAT.
    • If the creator of the GRAT passes away during the term of the trust, then the assets are pulled back in to the decedent’s estate by operation of IRC 2036.
  • There are strategies such as the Shelf or Rolling GRAT that can help reduce the volatility associated with rapid changes in 7520 Rates moving forward.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment. The material presented is provided for informational purposes only. There is no guarantee that any strategies discussed will result in a positive outcome. None of the above should be considered tax or legal advice. You should discuss any legal, tax or financial matters with the appropriate professional. Projections or other information regarding the likelihood of various outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Additionally, it is important to note that information in this report is based upon financial figures input as of the writing of this article; results provided may vary.