A. Interest rates can affect strategies for minimizing estate taxes and taking advantage of income tax breaks in several different ways. Here are 4 tactics recommended by a recent WSJ article for wealthy families:
1. Intrafamily Loans
You can lend money to your adult children to invest, you will take back a promissory note on which the children pay interest. Tax rules require the minimum interest rate the parents must charge to avoid having a below-market rate loan which will be treated as a taxable gift. Such a market rate varies, right now ranges between 0.56% to 2.61%, depending on the term of the loan.
When the rate increases, the rate of return the borrowers will need to pay will be higher which makes this tactic less attractive.
2. Grantor Retained Annuity Trusts
GRATs are used by wealthy individuals to pass down appreciating assets to heirs without taking a big gift-tax hit and to lower the overall estate-tax burden. GRATs are set with 2 or more years' terms, and often funded with assets with high growth potential. The parent who creates GRAT usually receives annuity payments from the trust that add up to the asset's original value plus a market-based interest rate set by tax rules. When the assets in GRAT generate a total pretax return that exceeds the hurdle rate, the excess return passes to heirs free of gift and estate taxes.
With the rate increases, you might want to set up a new GRAT to lock in today's low rate.
In our next blogpost, we will share two more tactics a wealthy family could do when the rates start rising.