Not Another Estate Planning Article On The Ongoing Lifetime Exemption Reduction Chambliss, Bahner & Stophel, CP
If you don’t follow the IRS’s release of federal interest rates, they recently announced the Federal Applicable Rates (AFR) for March 2021. The March AFR for medium-term notes is 0.62% . For reference, just a year ago, when the pandemic started, it had fallen to 1.52%, and two years ago the rate in March 2019 was 2.59%. The point is, interest rates are insanely low!
I know you are wondering, “Why do I care? You may also be wondering, “What is an AFR rate ?!” Don’t worry, I am NOT going to talk about the ins and outs of tax rulings that provide for the applicable federal rates, although that would be fascinating, I’m sure! Basically, it’s important to know that there are several estate planning techniques that take these rates into account and this affects their ultimate effectiveness.
In an age when interest rates are insanely low, like today, some techniques are even more tax efficient than usual.
Three techniques are:
- Settlor’s retained annuity trust
- Master Annuity Charitable Trust
- Intra-family loans
Annuity trust kept by the settlor (FREE)
When you create a Grantor Retained Annuity Trust (FREE), the grantor will receive an income stream, at least once a year, for the life of the trust. Payment is based on the present value of the assets using the effective AFR rate. Because of this payment requirement, there is often little to no estate tax exemption used when funding a FREE.
As interest rates go down, the payment required also goes down. When interest rates are low, it is easier for the growth and income generated by the assets of the trust to exceed the payments required, leaving more assets inside the trust at the end of the day. . When the trust ends, whatever remains in the trust is transferred to the remaining beneficiary – often children or trusts established for the benefit of the children.
If you create a FREE today, as long as the assets inside the trust increase by more than 0.8%, there will be assets left in the trust for the other beneficiaries at the end of the trust.
While the concept of a FREE may seem relatively straightforward, it takes a skilled practitioner to draft the documents appropriately to ensure that they are properly structured. In addition, it will be important to discuss other details and rules surrounding this technique to ensure that this tool matches your short and long term goals and plans.
Charitable Lead Annuity Trust (CLAT)
Similar to a FREE, a Charitable Lead Annuity Trust (CLAT) makes fixed annual payments from the trust, but instead of making payments to you, they go to a public charity. This is an added bonus if you are a charity and want to plan a fixed annual amount for various charities.
Like a FREE, this payment is also based on the present value of the assets using the effective AFR rate, so there might be minimal or no inheritance tax involvement, and at the end of the estate. duration, any assets remaining in the CLAT will be distributed to the other beneficiaries – usually your children or trusts for the benefit of your children. Another distinguishing feature of a CLAT is that you can claim a charitable deduction in the year you fund it.
Again, you will need someone skilled in estate planning to draft these documents and help you decide if this is a good option for you and your ultimate goals.
The simplest of the options, an intra-family loan, is a loan that you give to family members, trusts, or various other entities. Unlike previous techniques, you cannot effectively move assets out of your estate without using an inheritance tax exemption using intra-family loans. However, you can freeze the value of the ticket in your estate. The only growth you will experience over the life of the ticket is the interest generated by the ticket. This rate is based on the AFR rate and the length of the ticket. For a nine-year note created today, the interest rate should be 0.62% (for comparison purposes, the same note should have used an interest rate of 2.59% in March 2019) .
For example, if you loan your favorite estate planning attorney $ 1,000,000 today with a lump sum payment after nine years (I’m happy to take cash, a check, or a money order!) , you would charge 0.62% interest. Each year that person would pay you $ 6,200 in interest. After nine years that note would still only be worth $ 1,000,000 and hopefully your favorite estate planner has invested wisely and has over $ 1,000,000 left.
For reference, I did a very thorough and scientific research. After searching for two minutes, Google told me that the best certificate of deposit (CD) on the market is currently paying 1.25% interest. If I borrowed $ 1,000,000 from you and invested it in a CD that paid 1.25% interest, in nine years I would have $ 1,118,292. After paying you $ 6,200 in interest each year, I would still have $ 62,492 that was transferred to me with no inheritance tax impact.
Even though this is the easiest option, there are several things to consider before doing so. Chambliss can help you decide how best to structure an intra-family loan, what type of terms to use, whether to grant the loan to people, trusts or partnerships, how to refinance pre-existing notes and how to administer or manage a ticket during its term.
Ultimately, our goal is to make sure you make decisions that are not only effective in helping you and your family achieve your goals, but are also effective – both from a cost perspective. and time and from an ongoing administrative point of view – for you there.