No Harm
Here’s how it works: A rich family will put a stock or other asset in a GRAT, a transaction that is technically a loan. If the stock rises in value, those proceeds go to beneficiaries tax-free. If the stock drops, there’s no harm done -- shares just go back to the donor.
“It’s not ‘heads I win, tails I lose,’ it’s ‘heads I win, tails I break even,’” Stein said. Clients often set up multiple GRATs holding different investments, creating new ones whenever old trusts expire.
While they’re already widely used, “it’s a time when a lot of folks are looking at doing GRATs,” said Bryan Kirk, director of financial and estate planning at Fiduciary Trust Co. International.
One reason is market declines, which give assets in GRATs more upside potential. BBH’s Hutchinson also is advising clients to give up on old GRATs that have losses. She cites research by her firm showing that GRATs with even small initial losses are unlikely to succeed over their life. It’s better to start over with new GRATs, seeded with stocks now trading at lower valuations.
Plunging interest rates are another reason for new attention on GRATs. When taxpayers loan money to set up GRATs or other trusts, the IRS requires that trusts pay interest back to the lender. The rates, which are set by a formula and published each month, are a hurdle that GRAT investments must clear in order for returns to flow to beneficiaries.
The hurdle rate for a typical GRAT has fallen by half since the end of 2018, to 1.8% this month. That doesn’t reflect the impact of the Federal Reserve’s surprise rate cut on Tuesday. With Treasury yields hitting record lows, Stein expects the IRS’s April rate could drop to about 1.2% or even lower.
That means the wealthy may be tempted to wait until next month to start GRATs, though advisers say timing the market well is ultimately more advantageous than grabbing a slightly lower interest rate. “The thing that really makes a difference is what happens to asset values,” Fiduciary Trust’s Kirk said.
Similar IRS rules apply to loans within families, another popular strategy to pass on wealth while avoiding the estate tax. As the IRS-required rates drop, advisers say they’re helping rich families refinance those loans, so heirs and their trusts are paying less back to benefactors. Kirk also expects his clients to make more new loans to children and grandchildren, giving next generations the cash to ride out volatility.
“A lot of people don’t want to sell when the market is down,” Kirk said. “If they need liquidity, borrowing from an older generation that has cash available is an option.”
This article was provided by Bloomberg News.