How Higher Interest Rates Change Estate Planning Strategies

The benefits of different estate planning strategies change with interest rates. The advantages of different strategies changed significantly over the last couple of years as interest rates jumped higher. When interest rates rise, the pay- offs of some strategies increase while others lose some of their appeal. After a significant change in yields, reconsider strategies that were rejected a couple of years ago. You also might want to stop using other strategies.

In recent years, I recommended low-interest family loans as an estate planning tool. But now, higher interest rates must be charged on the loans to avoid negative tax consequences. The strategy is less attractive. Low-inter- est loans aren’t bad, but they’re not the great deal they were before 2022. See the June 2021 issue of for details about low-interest loans, in an article I presciently titled “This Could be the Retirement Watch Best Time to Make Low-Interest Family Loans.”

Higher rates also make grantor retained annuity trusts (GRATs) less attractive. GRATs have been popular for years. They produce the most ben- efits when funded with assets that are expected to appreciate rapidly over the next few years, such as stock of small, growing companies.

The grantor of a GRAT receives fixed annual payments of principal plus interest for a period of time that usually is two to five years. The trust retains or pays to the beneficiaries the investment returns that exceed the interest paid to the grantor. There are no gift or estate taxes on that amount.

Higher interest rates mean more must be paid to the grantor to avoid tax consequences, so the investments must earn higher returns to have the same benefits they did a few years ago. GRATs still can be useful but are likely to deliver lower benefits. On the other hand, charitable remainder trusts (CRT) and charitable gift annuities (CGAs) are more attractive at higher interest rates.

These tools pay income to the taxpayer (or ben- eficiaries designated by the taxpayer) for life or a period of years. A charity receives what’s left after the income payments stop. See the June 2023 issue of Retirement Watch for details about these strategies. When a CRT or CGA is set up, the taxpayer receives a charitable gift tax deduction equal to the present value of the amount the charity is projected to receive in the future.

Higher interest rates increase that present value and the tax deduction. In addition, higher rates mean a CGA will pay higher lifetime income to the donor than in the recent past. A charitable lead trust is the opposite of a CRT.

In a CLT, the charity receives income for a period of years before the property reverts back to the taxpayer or is transferred to a beneficiary named by the taxpayer. The tax deduction for funding a CLT is lower when interest rates are higher. Another strategy whose benefits increase when interest rates rise is the qualified personal residence trust (QPRT). In a QPRT, a taxpayer puts either a first or second home in a trust. (It’s usually best to use a second home.) The taxpayer retains the right to live in the home for a period of years.

Then, title to the home passes to the beneficia- ries of the trust, usually the taxpayer’s children. When the home is transferred to the trust, that’s a taxable gift equal to the present value of the home’s project- ed value when the trust beneficiaries receive it in the future. The higher current interest rates are, the lower the value of the gift. That means you can transfer the house out of your estate and keep it in the family at a lower gift tax cost than a few years ago. QPRTs weren’t used much when interest rates were low. But now that rates are higher, people with vacation homes should consider putting them in QPRTs.

These strategies all are called split interest gifts. In general, you continue to own or receive benefits from the property for a period of time before the property is transferred to either beneficiaries or charity. The values of the different interests are determined using formulas issued by the IRS. The interest rates used are known as the 7520 rates, also known as the applicable federal rates, issued monthly by the IRS.

You can find the latest rates by doing a web search for “applicable federal rates.” An estate planner can use software to show the tax benefits of the different strategies in your situation. There also are some free calculators on the web.