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Retirement Planning > Retirement Investing > Annuity Investing

Falling Interest Rates Put Some Planning Techniques In Play

By Lisa Oday

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Falling Interest Rates Put Some Planning Techniques In Play

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In todays falling interest rate environment, some sophisticated planning techniques, such as Grantor Retained Annuity Trusts (GRATs), can actually mean improved benefits for many clients.

GRATs and other split-interest trusts and installment transactions–such as charitable lead trusts (CLTs) and private annuities–are powerful tools in the financial planners universe of solutions. These techniques are even more effective in times of falling interest rates.

A GRAT is an asset-transfer technique in which an individual transfers an asset to a Grantor Retained Annuity Trust for a term of years, with the remainder passing to an individual or trust. GRATs are powerful estate-freeze tools, because they can be structured so that the income payments from the GRAT constitute a return of principal, with the growth being transferred to the GRAT beneficiary at a discount.

GRATS, along with Charitable Lead Annuity Trusts (CLATs), Charitable Remainder Annuity Trusts (CRATs), Grantor Retained Income Trusts (GRITs) and private annuities, rely on tables issued by the Internal Revenue Service to determine the value of interests retained or gifted.

These tables are published by the IRS in the third week of every month. They include the Applicable Federal Rates (AFRs) and the “7520 rate.” The 7520 is a calculated rate equal to 120% of the applicable federal mid-term rate rounded to the nearest 2/10 of a percent. Values in these tables may change monthly.

Lower 7520 rates mean the gift tax value of the remainder in a GRAT is lower. With the 7520 rate at 5.6% for October 2001, for example, a 65-year-old man can transfer $1 million to a trust and receive an annual payment of $70,000. At the end of 10 years, the remainder of the trust property passes to his daughter. The value of the fathers total retained annuity interest is $473,641. The gift to the daughter is $526,359.

By comparison, if this man had made the transfer in March 2000, when the 7520 rate was 8.2%, he would have had a total retained annuity interest of $422,030. The gift to his daughter would have been much larger–$577,970.

As you can see, when the 7520 rate is lower, as in the above example, the fathers taxable gift is much lower. All clients can appreciate such lower gift taxes. And for producers, this strategy demonstrates the knowledge and value they can bring to the planning process.

The private annuity also benefits from lower 7520 rates. In a private annuity transaction, a parent typically transfers property to a child in exchange for the childs promise to pay the parent a fixed, periodic income for life. When the fair market value of the property transferred equals the present value of the annuity, no gift tax is due.

If a private annuity is entered into during a period of lower interest rates, the fixed, periodic payment the child must make to the parent is lower. This is particularly important in cases in which individuals are avoiding making taxable gifts in the hopes (however faint) that estate and gift tax repeal will actually occur.

Suppose a parent, in exchange for a private annuity, transferred the $1 million family cattle ranch to her child in October 2001 with the 7520 rate at 5.6%. The annual payment to the parent would be $99,653. If the parent had made the transfer when the 7520 rate was 8.2%, the annual payment would have been $121,496. It takes a lot of beef to come up with that extra $21,843.

Lastly, Charitable Lead Annuity Trusts (CLATs) also can take advantage of lower interest rates. This technique involves a donor giving property to a charitable lead annuity trust for a term of years. During that term, the CLAT makes a fixed annuity payment to a charitable beneficiary, with the remainder passing to an individual or trust of the donors choosing. A decrease in interest rates increases the gift or estate tax deduction for the interest to charity, and decreases the gift tax value of the remainder.

With the Economic Growth and Tax Relief Reconciliation Act of 2001, it is commonly perceived that taxable gifts should not be made, due to the possibility that the gift and estate tax may actually be repealed. Until the dust settles on repeal versus reform, the cautious practitioner will rely on rolling two-year GRATs to transfer appreciation only out of the grantors estate.

Because CLATs and private annuities may also involve taxable gifts, they should be reviewed carefully to insure they fit the clients objectives.

, J.D., CLU, ChFC, is vice president-business planning for Jefferson Pilot Finiancial in Greensboro, N.C., Her email address is [email protected].

Reproduced from National Underwriter Life & Health/Financial Services Edition, October 8, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

Copyright 2001 by The National Underwriter Company. All rights reserved. Contact Webmaster

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