Tariffs, persistently high inflation and market volatility can stress even the most carefully designed financial plans. Let’s explore key estate-planning strategies designed to provide stability, protect assets and ensure your client’s financial intentions are honored, regardless of what the market may bear, especially in down markets with high interest rates.
Impact of Interest Rates on Planning Strategies
Fluctuations in interest rates may materially affect the appropriate timing for implementing certain estate-planning strategies. Each month, the Treasury issues the short-term, mid-term and long-term applicable federal rates based on established interest rates. The Internal Revenue Code Section 7520 rate (120% mid-term AFR) is an important element to monitor for sophisticated estate-planning strategies for its use in calculating charitable contribution deductions and transfer taxes. Importantly for charitable trust planning, IRC Section 7520(a) allows a taxpayer to elect the Section 7520 rate for either of the two months preceding the month of the transfer.
Grantor Retained Annuity Trusts
GRATs are irrevocable trusts created for a term of years (two at least, but commonly two or three years). The grantor of the GRAT transfers assets with high appreciation potential while retaining the right to receive annuity payments during the term of the trust. By providing the grantor an annuity interest, GRATs are powerful tools due to their ability to have the assets transferred, resulting in no gift tax to the grantor, known as a “zeroed-out GRAT.” A zeroed-out GRAT sets the annuity interest so that the present value of the annuity payments using the Section 7520 rate (which we sometimes refer to as the hurdle rate for GRATs) equals the value of the assets transferred to the GRAT. Following the expiration of the term, the assets, including all appreciation, pass to the beneficiaries of the GRAT, effectively removing the assets from the grantor’s taxable estate.
With the AFR rate currently relatively high, GRATs may seem like a difficult choice. However, when assets are depressed from market environments and clients are expecting exponential recovery, GRATs can be an efficient tool for transferring wealth with minimal gift tax consequences.
Trusts for Charitable Purposes
Charitably inclined individuals may consider charitable remainder trusts or charitable lead trusts, depending on interest rates at the time.
Charitable remainder trusts. CRTs are more ideal when the Section 7520 rate is higher. Annuity payments are made to the grantor during the trust term, with the remaining assets passing to the charitable beneficiary on termination of the trust. In addition to offering estate planning benefits, CRTs offer powerful income tax strategies to the grantor. While retaining an income stream, the grantor also benefits from a charitable deduction. When assets transferred to the CRT are sold, the CRT itself is deemed a tax-exempt entity, avoiding the payment of capital gain tax. Individuals can still take advantage of the higher Section 7520 rates of February and March if rates are anticipated to fall further. Nonetheless, CRTs are a useful strategy to provide donors with a lifetime income stream while supporting charitable causes and optimizing tax outcomes.
Charitable lead trusts. CLTs are particularly effective in lower interest rate environments, especially when funded with assets that have significant appreciation potential. CLTs are a type of irrevocable trust that provides payments to a charitable beneficiary during the term of the trust, with the remaining assets passing to noncharitable beneficiaries when the trust terminates. Suppose the CLT is taxed to the grantor. In that case, the grantor will be entitled to an individual charitable income tax deduction, offering an additional benefit for individuals in high-income tax brackets. Like GRATs, a CLT may be zeroed out, allowing the remaining assets in the trust, including appreciation, to pass to the noncharitable beneficiaries free of gift tax. CLTs are a viable option to consider if the Section 7520 rate continues downward.
Qualified Personal Residence Trusts. A QPRT is a useful estate-planning tool allowing clients to transfer a residence to beneficiaries at a minimized gift tax cost during a high-interest rate environment. Clients may continue to use the residence for a specified period. If the grantor survives the term, the grantor may continue to occupy the residence by paying rent, offering another mechanism to mitigate estate taxes. If the grantor dies before the end of the trust term, the transfer tax benefits may be eliminated due to the inclusion of the trust assets in the grantor’s taxable estate.
Other Notable Gifting Strategies
Gifting to 529 plans: A donor wanting to limit their gifts to the annual gift tax exclusion amount ($19,000 per person, per beneficiary in 2025), but who may feel like they want to do more currently, should consider taking advantage of the down market by gifting to a 529 plan for a child or grandchild. Specifically, individuals can superfund a 529 plan by making five years of contributions into a single gift that will not count against the individual’s federal gift tax exclusion. Note, however, that the death of the donor or the donor making additional gifts to the beneficiary of the 529 plan in any of the five years preceding the gift can cause estate and gift tax consequences.
Sale of underperforming assets to related persons: As the three major U.S. stock market indices continue to stumble, individuals can sell underwater positions to a related party (i.e., related non-grantor trust or family member). While the seller can’t use the loss, IRC Section 267(d)(1) of the Code allows the related buyer to only pay tax on a subsequent sale to the extent the gain exceeds the disallowed loss. Careful consideration of the related buyer and subsequent sale or disposition of the asset by the related buyer is necessary to avoid invalidating the benefits of this rule.
Transfer Tax Savings
These are noteworthy estate-planning techniques tailored for volatile markets that can help preserve individuals’ legacies, minimize risk and allow clients to confidently take advantage of changing financial landscapes. Choosing the right estate planning strategy to achieve a client’s goals requires careful evaluation of both technical requirements and personal circumstances. Those willing to exploit the current economic condition have an opportunity for transfer tax savings by implementing any one of the estate planning techniques discussed above.