Low interest rates can magnify the benefits of certain wealth transfer strategies. Estate planning techniques that take advantage of low interest rates can allow family wealth to remain in the family, mitigate potential transfer tax liability, and maximize philanthropic impact.

Many family wealth transfer strategies are more effective when interest rates are low.

Right now, interest rates are very, almost historically, low. Accordingly, the ability to take advantage of wealth transfer strategies that work better in low-interest-rate environments, such as Grantor Retained Annuity Trusts (GRATs), Charitable Lead Annuity Trusts (CLATs), and intra-family loans, remain available.

Below, we review three strategies that perform well in low-interest-rate environments. Keep in mind that personal circumstances and goals are significant factors to consider when choosing to implement a financial or estate planning strategy. Low interest rates in themselves are not a reason to implement a strategy.

Mitigating Federal Transfer Taxes

A number of the strategies discussed below refer to federal transfer taxes such as the estate tax, the gift tax, and the generation-skipping transfer tax. The estate tax, gift tax, and generation-skipping tax can be levied when wealth is transferred from one generation to the next. Simply following the news shows that these taxes are subject to ongoing public policy debate. The tax reform legislation of 2017 substantially increased federal estate and gift tax exemption levels, but the increase is temporary.[1] Given the uncertainty of future legislation and the potential need for the government to raise revenue, even if all federal transfer taxes were repealed, such repeal may not be permanent. It is important to understand that each of the strategies discussed below has implications beyond mitigating federal transfer taxes and income taxes. For example, transfers of family wealth may help to educate future generations on how to handle wealth, protect assets from creditors, or accomplish a charitable goal.

Grantor Retained Annuity Trusts

The estate tax, gift tax, and generation-skipping tax can be levied when wealth is transferred from one generation to the next. One common strategy for transferring wealth while mitigating federal transfer taxes is the grantor-retained annuity trust (shown in the GRAT Example below).[4] The success of a GRAT relies in part on trust assets growing at a rate that exceeds the IRC § 7520 rate (7520 rate), which is influenced by then-current interest rates.[2] A low 7520 rate maximizes the potential for success of a GRAT, with success being measured by the amount of wealth transferred with the lowest federal transfer tax, if any, being paid as a result of the transfer, shown in the 10-Year, $1 Million GRAT table below.

GRAT Example

Sam and Emily Smith would like to transfer assets to their children, but have already used their lifetime gift tax exemption. They would, nevertheless, like to avoid paying any gift tax when the transfer is made. A GRAT may be designed so the Smiths will receive annual distributions from the trust, pass on the remaining assets to the children in 10 years, and avoid being subject to gift tax. One of the factors that makes this strategy more effective is low interest rates.

10-Year, $1 Million Grantor Retained Annuity Trust*

Sec. 7520 Rate[3] Annual Distribution to Grantor IRS Value of Remainder for Gift Tax Purposes Actual Remainder to Family (Year 10)
2.0% (November 2019)[4] $111,326 $0 $327,489
5.0% (for comparison) $129,505 $0 $87,427
8.0% (for comparison) $149,029 $0 $0

*"Zeroed-out" 10-year GRAT initially funded with $1 million. Annual distribution to grantor based on creating a zero gift tax value. Assumes 2% income and 4% growth on GRAT principal. Some values have been rounded.
Source: Internal Revenue Service, PNC

Intra-Family Loans

Another way to pass on wealth to family members is through the use of loans. However, the IRS generally assumes intra-family loans are gifts.[5]

This presumption may be overcome as long as the loan is a bona-fide loan and there is a real expectation of repayment, shown in the Private Loan Example below. In addition, a minimum interest rate must be charged on the loan, known as the applicable federal rate (AFR).[6] The AFR is influenced by current interest rates. The borrower may invest the loaned assets such that the return the borrower receives is greater than the interest paid on the loan, shown in the $1 Million Private/Family Loan table below.

Private Loan Example

Kevin and Joan Miller would like to transfer wealth to their children who have a number of business opportunities. They want to avoid paying gift taxes and have used their lifetime exemptions. Instead of making gifts to their children, they could make loans. A loan of $1 million, with interest-only payments followed by a balloon payment in year nine, may provide the Millers with a means for transferring wealth to their children free of gift tax. (Note: the Millers will report on the interest they receive from the children.) The lower the applicable federal rates, the lower the interest on the loan, shown in the $1 Million Private/Family Loan table below.

$1 Million Private/Family Loan Example

Mid-Term AFR Interest Paid Annually Balloon Payment (End of Year 9) Net Amount Available to Junior Generation after Payment of Loan*
1.59% (Mid-Term AFR, November 2019)[7] $15,900 $1,000,000 $506,767
5.0% (for comparison)
$50,000 $1,000,000 $114,913
8.0% (for comparison) $80,000 $1,000,000 $229,826

*Assumes 6% growth on loaned assets less interest paid. Using appreciated assets to repay the loan could cause a capital gain.[8] This illustration does not take income tax attributable to loan interest or income tax on capital gains into consideration. Some values have been rounded.
** This result moves wealth from the junior generation to the senior generation.
Source: Internal Revenue Service, PNC

Charitable Lead Annuity Trusts

Families that wish to financially support the missions of charitable organizations or advance other philanthropic goals may seek to maximize the tax advantages of their charitable gifts. For those who plan to make consistent annual charitable gifts, a Charitable Lead Annuity Trust (CLAT) may provide a number of advantages. One of the tax benefits of a CLAT could allow the donor to receive a current-year income tax deduction for charitable gifts that will be made in the future, shown in the CLAT Example and the $1 Million Lifetime Charitable Lead Annuity Trust table below.[9]

CLAT Example

Jennifer Jones, a 65-year-old widow, has regularly supported charitable organizations in her community. Jennifer has an estate potentially subject to the federal estate tax. Jennifer would like to continue giving $50,000 each year to charity of for the rest of her life; and, following her death, she would like to pass property to her children and pay the least amount of estate tax. Jennifer may be able to accomplish these goals by contributing $1 million to a lifetime 5% CLAT, with $50,000 distributed to charity annually and the remainder passing to her children after her death without a federal estate tax being paid on these assets. Jennifer may also be able to take advantage of a current year income tax deduction, even though most of the payments to charity will not be made until future years. Note that the lower the 7520 rate generates a greater possible income tax deduction, shown in the $1 Million Lifetime Charitable Lead Annuity Trust table below.

$1 Million Lifetime Charitable Lead Annuity Trust*

Sec. 7520 Rate Annual Payment to Charity Remainder to Family (Life Expectancy)* Possible Current Year Income Tax Deduction**
2.0% (November 2019)[10] $50,000 $1,282,129 $691,293
5.0% (for comparison)
$50,000 $1,282,129 $539,625
7.8% (for comparison) $50,000 $1,282,129 $425,935

*Assumes trust has a 6% total return. To potentially receive a charitable deduction for the present value of the annuity in the year the CLAT is created, the trust must be a granter trust and Jennifer will report the CLAT's income on her income tax returns and pay the associated income tax. The income tax consequences to Jennifer are not illustrated in this example. Some values have been rounded.
**Subject to limitations regarding deductibility imposed by the Internal Revenue Code.
Source: Internal Revenue Service, PNC

Other Opportunities

The strategies discussed above are just a few of the ways to take advantage of low interest rates. Other options may be available depending on your particular goals and circumstances. For example, installment sales of business interests to a family member are more favorable for the buyer when interest rates are low. It is important to seek the advice of professional advisors familiar with your specific goals and financial situation before engaging in any tax strategy.

Low interest rates may provide an opportunity to effectively achieve your wealth transfer and legacy planning goals. Since 2010, rates have been historically low.

Now may be a good time to discuss these opportunities with your professional advisors.