The authors conclude that choosing the most appropriate wealth-transfer strategy also requires the careful assessment of an individual’s circumstances and objectives, and it may become necessary to reconsider some of these strategies if interest rates rise significantly from current levels or market dynamics shift.

Jaclyn G Feffer, senior fiduciary counsel and Patrick S Boyle, Southeast region head and senior investment strategist at Bessemer Trust, talk about the estate planning environment in economically difficult times. The editors of this news service are pleased to share these views and invite replies. The usual disclaimers apply to views of outside contributors. Email tom.burroughes@wealthbriefing.com

2022 has been a challenging year so far. Market turbulence has persisted throughout the year, and the economic environment has grown more complex in recent months given current geopolitical conflict, inflation reaching a 40-year high, and the Federal Reserve’s sharp pivot toward tighter monetary policy. 

While volatile financial markets can be deeply unsettling – and certainly present challenges – from a wealth planning perspective, depressed asset values can present some potentially useful opportunities. With interest rates moving higher, several timely wealth planning strategies are worth considering with clients today.

Considering lifetime and annual exclusion gifts
Rising inflation has obvious downsides, but from a planning perspective, it can be beneficial because the estate and gift tax exemption and the annual gift tax exclusion are both indexed for inflation and will increase at a faster rate. Recent inflationary adjustments to the lifetime gift tax exemption, for example, might leave clients asking: should my unused gift tax exemption or exclusion be used immediately? For those who are interested in making gifts and can afford to use their exemption, it is wise to do so soon as the exemption is scheduled to decrease in 2026. 

Current market volatility may create an advantageous environment for those planning to make gifts using the lifetime or annual exclusion from the gift tax with publicly traded securities suffering from reduced value. Gifts can be leveraged more effectively when values are depressed. Future growth reflecting the return to a higher value will directly benefit the recipient with no gift tax cost to the donor, though the cost basis for capital gains will carry over. Gifts of interests in closely held companies could also be worthwhile but could require an appraisal by a valuation firm. Other strategies might include gifting cash and allowing the recipient to invest or making gifts to a grantor trust so that the donor continues to pay the income taxes on behalf of the trust.
    
The annual gift tax exclusion increased in 2022 to $16,000 from $15,000 per gift to an individual (or $32,000 for a gift from a married couple to an individual), and donors should consider making these gifts annually.

Grantor retained annuity trusts (GRATS)
Individuals may establish grantor retained annuity trusts (GRATs) to transfer wealth free of any estate or gift tax. In the economic environment, GRATs remain an effective way to transfer wealth to beneficiaries while minimizing transfer tax liabilities.

Those leveraging GRATs can transfer their assets into a trust, generally for a short term, such as two years, while retaining the right to receive an annuity repayment of the original principal plus an interest rate called the 7520 or “hurdle” rate. Beyond the interest rate hurdle, any growth in the assets will be transferred free of estate or gift tax to the ultimate beneficiaries.

GRATs are timely given the current stock market downdraft. For example, a stock that typically trades at $100 per share, which is now valued at $80 per share due to market disruption, is transferred into a GRAT at $80. If the stock were to revert to its $100 expected value, this $20 increase (minus the Section 7520 rate interest cost) would be transferred free of any estate or gift tax and would avoid a potential future 40 per cent federal estate tax.

Additionally, while the 7520 rate is rising, it remains low by historical standards. A GRAT funded in July will only need to outperform the hurdle rate of 3.6 per cent to pass a tax-free gift to the remainder beneficiaries. Finally, the donor who set up the GRAT can pay the income tax on the trust, which is not considered a gift. 

Tax-free substitution of growth assets into grantor trusts
For income tax purposes, many families establish irrevocable trusts that qualify for grantor trust treatment, meaning that the donor is deemed to be the taxpayer, reporting the trust’s earnings on the donor’s tax return. 

Depending on the terms of a trust instrument, assets may be exchanged between the trust and the donor tax-free. Given market conditions, now is a good time for individuals to meet with their advisors to review their assets to determine whether assets with higher growth potential should be swapped into a grantor trust. More depressed assets with better current upside may be added to a trust, enabling the grantor to take back assets with lower expected returns over the term of the trust.

Low interest rate loans
To avoid loans being classified as gifts, in most cases, the tax code requires that loans be made with a minimum amount of interest, known as the applicable federal rate (AFR). The tax code assigns the necessary amount when no interest, or a lesser interest rate, is charged. If insufficient interest is charged, interest will be imputed, or the difference may be classified as a gift making it subject to tax.

Although interest rates are rising, they are still relatively low, and there are several tax-efficient loan strategies for consideration. For example, a parent may wish to make a low-rate loan directly to their child or descendants or to a trust for their child or descendants. More complex techniques might involve refinancing an existing loan to reduce the rate or selling assets to a trust in exchange for a promissory note.

Reviewing an estate plan today to preserve tomorrow’s wealth
The estate and gift tax strategies outlined here, along with income tax strategies such as Roth IRA conversions and tax loss harvesting, provide windows of opportunity in the current environment. 

While AFRs and the 7520 rate have been rising as the Federal Reserve continues hiking rates, they remain well below historic averages and can be locked in for a period of years through several of these strategies. More importantly, these rates are much less significant than the long-term growth potential afforded by using assets with depressed values – many of which may be down 20 per cent or more this year – for these strategies.

Beyond these macroeconomic considerations, choosing the most appropriate wealth-transfer strategy also requires the careful assessment of an individual’s circumstances and objectives. It may become necessary to reconsider some of these strategies if interest rates rise significantly from current levels or market dynamics shift. Experienced planning professionals can help clients weigh the potential benefits of different strategies to ensure that the maximum amount of their wealth will transfer tax efficiently to the people and causes they care about most. The key driver of planning, as always, remains a client’s individual goals.