Interest Rate Changes Affect Your Estate Plan

Interest rates are going to be higher for longer than investors expected at the start of the year, and that means estate planning strategies should be reassessed.

The benefits of different estate planning strategies change with interest rates.

When interest rates are higher, the payoffs from some strategies increase while other strategies lose some of their appeal.

For example, low-interest family loans can be effective estate and income tax planning tools. But now higher interest rates must be charged on the loans.

Take a fresh look at the numbers to determine if low-interest loans make sense for you. See the June 2021 issue of Retirement Watch for details about low-interest loans.

The use of grantor retained annuity trusts (GRATs) is being reassessed by some people because of the combination of higher interest rates and the potential for lower stock market returns in the next few years.

The grantor of a GRAT contributes property or money and receives fixed annual payments of principal plus interest from the trust over a period, usually two to five years.

The trust beneficiaries eventually receive the investment returns that exceed the interest paid the grantor.

Market interest rates determine the minimum amount the borrowers must pay to the grantor to avoid estate or gift taxes on the amounts paid to the beneficiaries.

GRATs produce the most benefits when funded with assets the grantor expects to appreciate rapidly over the next few years, such as stock of small, growing companies.

Higher interest rates mean the trust must pay more income to the grantor for the trust to maximize tax benefits. GRATs still can be useful but are likely to deliver lower benefits because of higher interest rates.

Charitable remainder trusts (CRTS) and charitable gift annuities (CGAs) are more attractive at higher interest rates.

These vehicles pay income to the taxpayer (or beneficiaries designated by the taxpayer) for life or a period of years. A charity receives what’s left after the income payments stop.

After contributing money or property to the CRT or CGA, the taxpayer qualifies for 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 the present value and therefore the deduction.

In addition, higher rates mean a CGA will pay higher lifetime income to the donor than in the recent past.

See the June 2023 issue of Retirement Watch for details about these strategies.

A charitable lead trust (CLT) is sort of the inverse of a CRT. The charity receives income for a period of years before the property reverts to the taxpayer or is transferred to a beneficiary. The tax deduction for funding a CLT is lower when interest rates are higher.

The qualified personal residence trust (QPRT) is more valuable after interest rates rise.

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 beneficiaries of the trust, usually the taxpayer’s children.

Transferring the home to the trust is a taxable gift equal to the present value of the home’s projected value when the trust beneficiaries receive it in the future.

Higher interest rates lower the value of the taxable gift. Today, you can transfer a house out of your estate and keep it in the family at a lower gift tax cost than a few years ago.

An estate planner can use software to show the tax benefits of each of these strategies in your situation. There also are some free calculators on the web.