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Wealth transfer strategies for volatile markets

Individuals 09.03.2020 6 MIN READ


Initiating a wealth transfer to family members during a period of extreme market volatility, like we’ve experienced in the past few months, may seem like an odd move. But, shifting assets when the market is turbulent and interest rates are relatively low can be a smart strategy.

Generally, transfers made to family members or trusts have two primary benefits:

  • Reduce the amount of your net worth that will face estate taxes
  • Post-transfer appreciation avoids federal gift and estate taxes

When the stock market drops, the depressed asset values enable you to transfer your assets at a lower gift value. This allows you to pass more assets to family members before reaching either the current annual $15,000 individual gift tax limit ($30,000 for married couples) or the lifetime limit of $11.58 million ($23.1 million for married couples). By selectively implementing estate planning strategies that minimize or avoid the gift tax, you can transfer your assets more effectively to younger generations. With these considerations in mind, let’s discuss wealth transfer strategies that may be ideal for this environment. Even if you’ve already integrated some of them, your Ayco advisor may be able to enhance their effectiveness.

Transfer assets to a Grantor Retained Annuity Trust

A grantor retained annuity trust (GRAT) potentially enables you to transfer wealth to the next generation of family members, with little to no gift taxes.

With a GRAT, you put appreciating assets into an irrevocable trust, and receive annual distributions over the term of the trust. You determine the length of the term, but two years is usually the shortest period allowed. Generally, you must live until the end of the trust term to benefit from a GRAT. If the grantor survives the term, then the assets go the trust remaindermen. If the grantor does not survive the term, then typically the entire trust assets will be included in the grantor's estate, as they would have without a GRAT in place.

The minimum amount of money you receive from the annuity is based partly on the monthly Internal Revenue Service (IRS) Section 7520 rate, which was at a historic low of 0.6% in July 2020. (During the term of the GRAT, the grantor takes back an annuity, which is calculated based upon the 7520 rate for the month of the funding.) The rate equals 120% of the applicable federal mid-term rate, rounded to the nearest two-tenths of a percent. The annuity amount is calculated to “zero out” the gift, so that the grantor does not need to use his or her lifetime exemption amount.

Here’s why this strategy works so well in a low-interest climate: If the value of your assets increases at a greater pace than the Section 7520 rate, the excess appreciation goes to family members (or their trusts) at the end of the GRAT term, gift tax free. Even if it doesn’t, you’ll still receive the Section 7520 rate—meaning you won’t be losing money in a worst-case scenario. In other words, if a GRAT is funded in July 2020 when the 7520 rate is 0.6% and, if the trust assets appreciate at more than 0.6%, that excess appreciation will pass to the trust remaindermen gift tax-free. In the event the assets do not appreciate or they lose value, the grantor will only be out the cost of setting up the GRAT.

So, when interest rates are low and assets appreciate significantly, a GRAT can be a savvy way to transfer wealth with little or no gift tax consequences.

Give to charities

A lifetime charitable lead annuity trust (CLAT) enables you to make periodic payouts to your favorite charity or even multiple charities, and then pass the trust assets to family members.

A CLAT lasts for a specific term (which might be represented as a specific number of years or the life or lives of designated individuals). After the charitable interest, any remaining funds go to family members or other beneficiaries directly or through a trust. The gift value is determined based on the date the trust is funded. Similar to a GRAT, if the trust assets exceed the 7520 rate, this appreciation will avoid the gift tax. You can reduce your initial gift tax by designating a higher amount of your assets to charity, and waiting longer to give any leftover money to your beneficiaries.

Provide an intra-family loan

This often-overlooked strategy can be a relatively easy, effective way to shift your wealth, especially in a low-interest setting.

In this scenario, you provide a loan to a family member (or create a trust for them) that can be used for any purpose—including buying a house, starting a business or taking advantage of an investment opportunity.

The rate is typically more favorable than what’s available on the market, which obviously benefits the borrower. But it must be at least equal to the Applicable Federal Rate (AFR) for the month of the loan. These rates are published monthly by the Internal Revenue Service (IRS). (For reference, the July 2020 AFR interest for a nine-year note was 0.45 %) If it’s lower than the AFR, the remaining “missing interest” will be treated as a taxable gift.

Even though the money is going to a family member, you should formally document the loan with a promissory note and track all principal and interest payments. Otherwise, the IRS could view the money as an upfront gift.

How will you benefit? Besides supporting a loved one with the loan, the rate of return on its proceeds likely will exceed the loan interest rates, and any appreciation will avoid gift or estate taxes. Additionally, if interest rates go even lower, you may be able to refinance as long as the loan terms permit it.

Sell interests in a family partnership

While you could gift your family limited partnership using the annual exclusion and lifetime exemption amounts, it may be better to sell your interests instead—perhaps to an adequately funded grantor trust. This is usually done in exchange for a promissory note, with an interest rate equal to the AFR.

With the current low interest rates, the sale could be quite advantageous. You’d benefit from greater flexibility than by simply gifting your partnership, plus generate cash through the interest and principal payments on the note.

Create an income stream

Most tax-friendly wealth transfer strategies rely on irrevocable lifetime transfers to reduce your net worth. It’s common, though, for even ultra-wealthy individuals to worry that doing so will leave them uncomfortably low on funds.

Creating a cash-flow stream when making your transfer can alleviate this anxiety. You might achieve this by using payments from a GRAT annuity or interest in connection with a loan to produce extra income.

Although these payments may be included in your estate, combining one of these options along with a thorough cash-flow analysis can help ensure an efficient transfer of your wealth to family members, while still providing enough funds for your current and future needs.

Before taking action

Wealth transfers can be complex. It’s best to consult with your Ayco advisor to determine if these strategies are appropriate for your situation, and how to maximize their advantages.



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