By John Ambrecht
For some time, I have been watching the effects of the COVID-19 crisis on federal interest rates that control estate planning options and strategies. I’ve also considered possible changes in the estate and gift tax law if Joe Biden were elected and power shifts in Washington.
Make no mistake: If you have significant assets you’d like to pass on to your children and perhaps your grandchildren, now is the time to do it.
Current applicable interest rates have reached historic lows, which have made certain estate planning options far more effective than they have been in the past. These interest rates are likely to go up in the months to come. At the same time, with the November election on the horizon and massive deficits looming, it’s possible a future president or Congress could raise estate tax rates and lower the exclusion amount.
Here’s a breakdown of why current conditions are so favorable:
• Estate taxes: The current estate tax exclusion per spouse is now $11.58 million (compared to Biden’s plan of $3.5 million). After reducing that amount by any lifetime taxable gifts and using one of four planning options I will present below, you can transfer very large amounts of family wealth to your heirs at a fraction of the value that would otherwise apply.
• Very low “Applicable Federal Rates (AFRs)”: AFR rates in August range from 0.17 percent to 1.12 percent, depending on the length of the note. Compare those with AFR rates for April of 2018, which were between 2.12 percent and 3.2 percent. Additionally, the IRS assumes that a trust earns 0.4 percent per year now, versus 3.2 percent per year in April 2018.
The difference? If you had a $1 million long-term note for 10 years, the interest due under current rates would be $112,000, compared to $349,145 in April 2018.
What tools are available to take advantage of the current planning situation? I will explain a few techniques that can be used to shift assets to your heirs while still, in most cases, retaining access to those assets:
• A Grantor Retained Annuity Trust: A married couple transfers income-producing assets to a special, irrevocable trust and retains the income for a designated period of time. When the designated term expires, the assets in the trust pass to the remainder beneficiaries (family members). The value of the gift is the discounted remainder value of the gift. Under the current interest rates, this allows for wealth transfers unlike anything that has been obtainable in many years.
• A Spousal Lifetime Access Trust allows you to shift an asset to an irrevocable trust for your spouse, who can use the income generated by that asset for your common benefit. The trust enjoys creditor protection for the donating spouse and the beneficiary spouse, and still allows for future appreciation to grow free of estate and gift taxes for the benefit of the next generation.
• Domestic Asset Protection Trusts: For this, each spouse, as settlors, will transfer assets to an irrevocable trust in one of the 19 states that allow the settlor to be a possible indirect beneficiary of the trust and still give the assets in the trust creditor protection. Both spouses will use their entire estate and gift tax exclusion amount during their lifetimes and get grandfathered into the current $11.58 million per spouse, and all future appreciation on the assets gifted to these trusts. Special terms in the trust provide that the settlors are not the income beneficiaries of the trust per se. Instead, an independent person, or “special trustee,” will have the power to allocate income to them.
• PPFs: A Preferred Partnership Freeze is designed to shift future appreciation out of your estate while still allowing you to keep control of the asset. You will be the general partner and then gift the limitedpartnership interests to a gift trust for your children and grandchildren.
Your general partnership interest in the capital account also generates a preferred return in addition to your right to the return of your capital account. This is all paid before making distributions to the limited partners.
This is only a brief explanation of these planning options, but it gives you a sense of how unique the opportunities are at this time.
• John Ambrecht is a senior partner at the estate planning and tax specialty law firm Ambrecht & Associates in Santa Barbara.