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Estate Planning: Interest Rate Drop Enhances Wealth Transfer Opportunities

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Wealth managers consider many factors when designing and implementing wealth transfer strategies for their high-net worth clients. The appreciation potential of the client’s personally owned assets, the liquidity needs of the estate, the charitable intent of the client, and the needs of estate beneficiaries are commonly mentioned as primary factors when preparing estate plans. There are instances, however, when other variables may drive decision making.

The applicable federal rate (AFR), published monthly by the IRS and monitored closely by estate planners, recently fell 0.4%, to reach 2.8% in early July. The AFR is integral to the technical design of several popular wealth transfer techniques, including grantor-retained annuity trusts (GRAT), charitable remainder and charitable lead trusts (CRT, CLT), qualified personal residence trusts (QPRT), and various installment arrangements. Over the past 20 years, it has fluctuated between a historical low of 2% February 2009 and a historical high of 11.6% in May 1989. So what does its recent movement toward the historical low mean for you?

Strategies to consider when interest rates fall

As mentioned previously, the AFR is a key factor in the design of several estate planning strategies. Which among those strategies is enhanced when the AFR falls?

Estate planning techniques that involve some form of an installment sale between family members and intra-family loans are apt to benefit from a reduction in interest rates because the minimum rates of interest charged to avoid gift tax issues also fall. Clients who plan to enter into installment sales or intra-family loans may find it beneficial to take advantage of these rates now. Additionally, clients with existing installment sales or intra-family loan arrangements might consider refinancing their arrangements to take advantage of today’s lower rates.

Charitable intent

Clients with charitable intent may be interested in exploring the use of a charitable lead annuity trust (CLAT) to help fulfill their charitable goals while enhancing their wealth transfer planning. A CLAT is a split-interest trust, meaning the trust has two beneficiaries, a primary and a remainder. The primary or lead beneficiary is designated to receive an income stream for the term of the trust; a qualified charity serves as lead beneficiary. The remainder beneficiary receives all remaining assets in the trust after the lead beneficiary’s interest expires at the end of the trust term. For wealth transfer purposes, the client’s children are a common choice for a remainder beneficiary.

So why would a reduction of the AFR enhance a CLAT? A transfer to a nongrantor CLAT is a taxable gift. When the client first transfers assets to the nongrantor CLAT, the present value of the remainder interest must be calculated to determine the amount of the taxable gift. The AFR is one of the primary factors in this calculation; it is the rate at which the IRS assumes CLAT assets will appreciate over the trust term. A lower AFR results in a lower present-value calculation and therefore a smaller taxable gift. One more potential benefit of the CLAT strategy is that, if CLAT assets appreciate at a rate above the AFR over the term of the trust, the appreciation occurs outside of the client’s taxable estate and is passed along to the remainder beneficiaries (e.g., the children) free of wealth transfer taxes.

Another technique that benefits from a reduced AFR is the GRAT. A popular wealth transfer strategy, it is similar to a CLAT in that it is a split-interest trust. With a GRAT, however, the lead or retained interest is for the benefit of the grantor (i.e., the client who creates the trust) rather than for the benefit of a qualified charity. Also similar to a CLAT, the transfer of assets to the GRAT is a taxable gift to the remainder beneficiaries. Again, the amount of the taxable gift is calculated using the AFR to determine the present value of the remainder interest. A lower AFR results in a reduced taxable gift.

For clients considering a GRAT, the time to act is now. Not only is the AFR near historical lows, but pending estate tax legislation, if passed, will hamper the usefulness of the GRAT strategy going forward. Opportunities to transfer wealth in a tax-efficient manner through a GRAT may be greatly reduced.


The implementation of wealth transfer strategies requires us to consider several factors in the design of our plans. There are times when those factors change in such a way that we can use them to our advantage. The reduction of the AFR to near historical lows is one of those opportune times; explore your clients’ situations and look to determine whether they might benefit from this recent change.

Gavin Morrissey is the director of advanced planning at Commonwealth Financial Network, in San Diego, California. He can be reached at [email protected].


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