On July 31, 2019, the Federal Reserve cut interest rates for the first time in over a decade. Although this may be bad news for your savings account, it may be good news for your estate plan. This is because certain popular estate planning techniques become available that do not lend themselves to a high-interest-rate environment.
The first such technique is a grantor retained annuity trust, known in the estate planning world as a “GRAT.” A GRAT is a mechanism whereby a grantor transfers assets to an irrevocable trust and retains the right to receive annuity payments for a predetermined period of time. When the GRAT term ends, the trust assets, and any appreciation in value of such assets, are passed to the beneficiaries free of taxes. However, if the grantor dies during the GRAT term, the trust assets are drawn back into the grantor’s taxable estate, and the benefit of the transaction is lost.
A second technique to consider is the sale of assets to an intentionally defective grantor trust, commonly known as an “IDGT.” In this transaction, a grantor sells appreciated assets to an IDGT in exchange for an interest-bearing note for the purchase price. Because the trust is structured as a grantor trust, the gain on the sale is ignored for federal income tax purposes. In addition, if the trust instrument is drafted properly, the grantor will no longer be treated as the owner of the assets, and the assets will not be included in the grantor’s taxable estate. This lack of synchronization within the tax code currently permits taxpayers to enjoy the “best of both worlds” in terms of income tax and estate tax treatment.
GRATs and IDGTs are most advantageous to taxpayers when interest rates are low. While no one can predict exactly how long today’s low interest rates will last, it is probably a safe assumption that they will not last forever.
The results of the upcoming election could also determine the fate of GRATs and IDGTs. Proposed legislation put forth by presidential candidate Bernie Sanders would eliminate or greatly restrict the availability of these techniques, and would also dramatically reduce today’s generous estate and gift tax exemptions. Although Sanders’ proposals currently stand no chance of passage, this could change if the Democrats win the presidency and both chambers of Congress. Taxpayers are well-advised to explore these estate planning opportunities sooner rather than later.