Interest Rates Impact Trust Strategies

Interest Rates Impact Trust Strategies

With the Fed predicting multiple additional interest rate hikes this year, it’s clear that the halcyon days of rock bottom rates is coming to an end.

Financial advisors need to carefully consider how the new rate environment will impact clients considering trust strategies. For grantor retained annuity trusts (GRATs) and charitable lead annuity trusts (CLATs), this could be an advantageous period.

A GRAT is a trust established for a specified time period that includes an annuity paying the GRAT creator a predetermined sum every year that the trust is in existence. The annuity is the retained interest, while the remaining value passes on to the beneficiaries and is thus excluded from the client’s estate.  The gift to the beneficiaries is taxable, based on the fair market value of the property included in the trust less the retained interest. That retained interest is the actuarially calculated value of the annuity the client will receive over the GRAT’s existences based on the Section 7520 rate effective in the month the trust was created.

A lower rate will increase the present value of the retained interest, and thus will reduce the value of the gift to the beneficiary. For the trust to be a success, the assets only need to appreciate at a rate higher than the 7520 rate. Locking in assets at today’s rates when rates are expected to rise makes it likely that the assets will appreciate at a superior rate.

CLATs are the same idea, more or less, except a charity receives the annuity payment. The client’s goal is often to maximize the value of the charitable deduction. As with a GRAT, the client’s beneficiaries received the trust assets. The interest rate is locked in at transfer of the assets into the trust, and excess performance is passed to the non-charitable beneficiaries tax free. Plus, the donor gets a deduction for the assets that go to the charity.

Qualified personal residence trusts (QPRTs) benefit from high interest rates. A client transfers his or her home into the trust but retains the right to continue living there. The remainder is transferred to the beneficiaries, taking advantage of the gift tax exemption. If the client’s remainder interest – the value of continuing to live in the home) is high, less of the exemption is used. When rates are high, the value of the interest passed to beneficiaries is lower.

To learn more about structures that may be desirable in a higher rate environment, please see:
As Interest Rates Change, So Must Trust Strategies | ThinkAdvisor


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