High Interest Rates Have an Impact on Estate Planning

The Section 7520 rate has been low for the past 15 years and presented many opportunities for good planning. What happens when inflation has returned and rates are moving up, asks a recent article titled “Estate Planning Techniques in a High—Interest—Rate Environment” from Bloomberg Tax.

The Section 7520 rate is the interest rate for a particular month as determined by the IRS. It is 120 percent of the applicable federal midterm rate (compounded annually) for the month in which the valuation date falls and rounded to the nearest two-tenths of a percent. It is used for actuarial planning, to discount the value of annuities, life estates and remainders to present value, and is revised monthly.

In January 2022, the 7520 rate was at 1.6%, but as interest rates increased, it shot up and in December 2022 was 5.2%. This was a 225% increase—unprecedented in the history of the 7520 rate. However, there are four key planning concepts which may make 2023 a little brighter for estate planning attorneys and their clients.

Higher inflation equals higher exemptions. Certain inflation adjusted exemptions and exclusions increased on January 1, 2023. The federal transfer tax exemption rose by $860,000 to $12.92 million, and the annual gift tax exclusion increased to $17,000 from $16,000 in 2022.

These increases give wealthy families the opportunity to make generous new gifts to family members without triggering any transfer taxes. Those who have fully used transfer tax exemptions may wish to consider making additional transfers.

Shift charitable giving to CRTs for higher interest rates. People who might have started Charitable Lead Trusts should instead look at Charitable Remainder Trusts. With both CLTs and CRTs, the value of the income and remainder interests are calculated using the 7520 rate. The key difference, for estate planning purposes, is the impact of a rising rate on the amount of the available charitable deduction.

The return of the QPRT. Qualified Personal Residence Trusts have been hibernating for years because of low interest rates. However, the time has come to return them to use for wealth transfer. A QPRT lets a person transfer a residence at a discounted value, while retaining the right to occupy the residence for a number of years. The 7520 rate is used to determine the value of the owner’s retained interest. The higher the rate, the more value retained by the owner and the smaller the amount of the taxable gift to the remainder beneficiaries, usually the owner’s children.

GRATs still have value. A Grantor Remainder Trust should still be considered in estate planning. A GRAT is more appealing in a low interest environment. However, a GRAT can still be useful when rates are rising. The success or failure of the GRAT usually depends on whether the assets transferred to the GRAT appreciate in value at a rate exceeding the 7520 rate, since the excess appreciation is transferred to the remainder beneficiaries gift tax-free. A GRAT can also be structured as a zeroed-out GRAT. This means that the transfer of assets to the GRAT doesn’t use any of the grantor’s transfer tax exemption or result in any gift tax due. This is still of value to a person who owns assets with significant growth potential, like securities likely to rebound quickly from depressed 2022 values.

Reference: Bloomberg Tax (Dec. 23, 2022) “Estate Planning Techniques in a High—Interest—Rate Environment”

What’s Is the Best Way to Give to Charity?

Charitable giving plays a valuable role in estate and tax planning. A well-planned donation can also provide a healthy income tax deduction, along with a reduction of estate taxes. Your generous donation could help to maintain financial security, exert control over assets during life and after death and provide for heirs, as explained in a recent article titled “Charitable giving good for heart, 1040” from the Valdosta Daily Times.

To accomplish any of these objectives, you’ll want to work with an experienced estate planning attorney who can help tailor an estate plan to your individual circumstances. Here are some strategies to consider.

Gifts of appreciated property might allow you to avoid capital gains tax owed when the asset is sold and, if planned properly, might allow you to receive an income tax deduction, usually worth the fair market value of the asset.

Removing any assets from your estate reduces the potential estate tax liability.

If you want to make a donation to a charity but you’d like to maintain some control over it, a Charitable Remainder Trust (CRT) might be a good fit. A CRT works best when funded by an appreciated asset, such as real estate or stock in a family owned business.

Once the property is transferred to the CRT, the CRT can sell the appreciated assets it holds without paying capital gains taxes. It then continues to provide income generated by the CRT to the beneficiaries for a period of time, as instructed by the CRT. At the end of this period, the remainder of the CRT is donated to the charity. You avoid capital gains on the assets you donated, an income stream and you also receive a tax deduction.

Another strategy is to use a Charitable Lead Trust or CLT. With a CLT, you give the charity the use of the asset and the right to any income generated for a predetermined time. When the time period ends, the asset reverts to you or is given to whoever you designate in the CLT. Appropriate assets for a CLT could be income-producing stocks and bonds, a valued collection or a painting transferred to a museum for a certain period of time.

You likely receive a current income tax deduction for the value to the charity. However, you receive no other direct benefit during the term. If a CLT is created upon your death, estate tax liability could be reduced.

Early tax planning can help make the most of any charitable giving opportunities and let you take full advantage of any additional benefits. Talk with an experienced estate planning attorney to receive guidance appropriate to your unique situation.

Reference: Valdosta Daily Times (Dec. 4, 2022)  “Charitable giving good for heart, 1040”

Should I have a Charitable Trust in My Estate Plan?

Charitable trusts can be created to provide a reliable income stream to you and your beneficiaries for a set period of time, says Bankrate’s recent article entitled “What is a charitable trust?”

Establishing a charitable trust can be a critical component of your estate plan and a rewarding way to make an impact for a cause you care deeply about. There are a few kinds of charitable trusts to consider based on your situation and what you may be looking to accomplish.

Charitable lead trust. This is an irrevocable trust that is created to distribute an income stream to a designated charity or nonprofit organization for a set number of years. It can be established with a gift of cash or securities made to the trust. Depending on the structure, the donor can benefit from a stream of income during the life of the trust, deductions for gift and estate taxes, as well as current year income tax deductions when the assets are donated to the trust.

If the charitable lead trust is funded with a donation of cash, the donor can claim a deduction of up to 60% of their adjusted gross income (AGI), and any unused deductions can generally be carried over into subsequent tax years. The deduction limit for appreciated securities or other assets is limited to no more than 30% of AGI in the year of the donation.

At the expiration of the charitable lead trust, the assets that remain in the trust revert back to the donor, their heirs, or designated beneficiaries—not the charity.

Charitable remainder trust. This trust is different from a charitable lead trust. It’s an irrevocable trust that’s funded with cash or securities. A CRT gives the donor or other beneficiaries an income stream with the remaining assets in the trust reverting to the charity upon death or the expiration of the trust period. There are two types of CRTs:

  1. A charitable remainder annuity trust or CRAT distributes a fixed amount as an annuity each year, and there are no additional contributions can be made to a CRAT.
  2. A charitable remainder unitrust or CRUT distributes a fixed percentage of the value of the trust, which is recalculated every year. Additional contributions can be made to a CRUT.

Here are the steps when using a CRT:

  1. Make a partially tax-deductible donation of cash, stocks, ETFs, mutual funds or non-publicly traded assets, such as real estate, to the trust. The amount of the tax deduction is a function of the type of CRT, the term of the trust, the projected annual payments (usually stated as a percentage) and the IRS interest rates that determine the projected growth in the asset that’s in effect at the time.
  2. Receive an income stream for you or your beneficiaries based on how the trust is created. The minimum percentage is 5% based on current IRS rules. Payments can be made monthly, quarterly or annually.
  3. After a designated time or after the death of the last remaining income beneficiary, the remaining assets in the CRT revert to the designated charity or charities.

There are a number of benefits of a charitable trust that make them attractive for estate planning and other purposes. It’s a tax-efficient way to donate to the charities or nonprofit organizations of your choosing. The charitable trust provides benefits to the charity and the donor. The trust also provides upfront income tax benefits to the donor, when the contribution to the trust is made.

Donating highly appreciated assets, such as stocks, ETFs, and mutual funds, to the charitable trust can help avoid paying capital gains taxes that would be due if these assets were sold outright.  Donations to a charitable trust can also help to reduce the value of your estate and reduce estate taxes on larger estates.

However, charitable trusts do have some disadvantages. First, they’re irrevocable, so you can’t undo the trust if your situation changes, and you were to need the money or assets donated to the trust. When you establish and fund the trust, the money’s no longer under your control and the trust can’t be revoked.

A charitable trust may be a good option if you have a desire to create a legacy with some of your assets. Talk with an experienced estate planning attorney about your specific situation.

Reference: Bankrate (Dec. 14, 2021) “What is a charitable trust?”

How Does a Charitable Trust Help with Estate Planning?

Simply put, a charitable trust holds assets and distributes assets to charitable organizations. The person who creates the trust, the grantor, decides how the trust will manage and invest assets, as well as how and when donations are made, as described in the article “How a Charitable Trust Works” from yahoo! finance. An experienced estate planning attorney can help you create a charitable trust to achieve your estate planning goals and create tax-savings opportunities.

Any trust is a legal entity, legally separate from you, even if you are the grantor and a trustee. The trust owns its assets, pays taxes and requires management. The charitable trust is created with the specific goal of charitable giving, during and after your lifetime. Many people use charitable trusts to create ongoing gifts, since this type of trust grows and continues to make donations over extended periods of time.

Sometimes charitable trusts are used to manage real estate or other types of property. Let’s say you have a home you’d like to see used as a community resource after you die. A charitable trust would be set up and the home placed in it. Upon your death, the home would transfer to the charitable organization you’ve named in the trust. The terms of the trust will direct how the home is to be used. Bear in mind while this is possible, most charities prefer to receive cash or stock assets, rather than real estate.

The IRS defines a charitable trust as a non-exempt trust, where all of the unexpired interests are dedicated to one or more charitable purposes, and for which a charitable contribution deduction is allowed under a specific section of the Internal Revenue Code. The charitable trust is treated like a private foundation, unless it meets the requirements for one of the exclusions making it a public charity.

There are two main kinds of charitable trusts. One is a Charitable Remainder Trust, used mostly to make distributions to the grantor or other beneficiaries. After distributions are made, any remaining funds are donated to charity. The CRT may distribute its principal, income, or both. You could also set up a CRT to invest and manage money and distribute only earnings from the investments. A CRT can also be set up to distribute all holdings over time, eventually emptying all accounts. The CRT is typically used to distribute proceeds of investments to named beneficiaries, then distribute its principal to charity after a certain number of years.

The Charitable Lead Trust (CLT) distributes assets to charity for a defined amount of time, and at the end of the term, any remaining assets are distributed to beneficiaries. The grantor may be included as one of the trust’s beneficiaries, known as a “Reversionary Trust.”

All Charitable Trusts are irrevocable, so assets may not be taken back by the grantor. To qualify, the trust may only donate to charities recognized by the IRS.

An estate planning attorney will know how to structure the charitable trust to maximize its tax-savings potential. Depending upon how it is structured, a CT can also impact capital gains taxes.

Reference: yahoo! finance (Dec. 16, 2021) “How a Charitable Trust Works”

Should a Charitable Lead Trust Be a Part of My Estate Planning

A charitable lead trust is usually implemented after other basics are done, such as your will, powers of attorney and health care directive, says Tri City Business News’ recent article entitled “Charitable lead trusts do good while reducing estate taxes.”

A charitable lead trust is a separate, standalone trust.

Let’s say there’s a married couple with some extra money who want to benefit a charity. The couple has an attorney draft a Charitable Lead Trust (CLT). The terms of the trust say that, for the lifetime of the couple (or the surviving spouse), the CLT will annually pay 5% of the trust to a qualified charity. At the death of the surviving spouse, the money left in the trust will go to the couple’s children. This is called a “split-interest” gift, where a portion of the gift to the trust goes to charity and a portion will ultimately go to the children.

The current interest rate is used to actuarially set the amount of the gift going to the children, which the parents will use to file a gift tax return.

With a few exceptions, there’s no tax assessed on a gift like that. It’s just required by law to report gifts that size to the IRS.

In a low interest rate environment, the calculated (the actuarially determined) amount going to the children will appear to be lower. However, the actual amount could be much higher, based on the performance of the assets in the trust.

For the calculation, because the amount going to the children appears lower, the calculated amount going to the charity must be higher.

Neither the parents nor the children get anything from the trust during the parents’ lifetime. In that way, it’s like a will where nothing goes to the children until the deaths of the parents. What makes a charitable lead trust attractive is the added ability to give to charity and engage in potential wealth transfer tax mitigation.

In addition, a charitable lead trust has another benefit: it potentially provides a consistent and reliable stream of income to your favorite charity for years to come. As such, in addition to acting as a legallysanctioned wealth transfer technique, it provides a wonderful benefit to worthy organizations.

Reference: Tri City Business News (Aug. 2021) “Charitable lead trusts do good while reducing estate taxes”