Strategies For A High-Interest-Rate Environment
As the interest rates rise, you can capitalize on high interest rate strategies to reduce the actuarial value of a taxable gift. The higher the rate, the more beneficial these strategies will be.
First, there is a qualified personal residence trust (QPRT). A QPRT is a trust used to transfer a personal residence to trust beneficiaries. The QPRT lasts for a term of years, during which the grantor may continue to use the residence as his or her own. After the initial QPRT term, the residence passes to remainder beneficiaries. If the grantor wants to continue to live in the home, the trust or its beneficiaries can rent it to the grantor at a fair-market-value rent. The initial transfer to the QPRT is a taxable gift of the value of the remainder interest, calculated using the §7520 rate. The higher the rate, the higher the value of the grantor’s right to use the residence as his or her own during the term of years, and the lower the value of the gift of the future remainder interest. So as the §7520 rate increases, the taxable gift decreases, making the QPRT a more attractive strategy with higher interest rates.
Second, is the charitable remainder annuity trust (CRT): With a CRT, the grantor receives an annuity from the CRT for a term of years, and the charity receives whatever remains at the end of the term. Here, the value of the remainder, calculated using the §7520 rate at the time the grantor creates the trust, gives the grantor an income tax charitable deduction. However, in order to pass IRS review, the value of the remainder must reach a minimum threshold; the higher the §7520 rate, the higher the value of the charitable interest and the more likely that the CRT will pass IRS review. CRTs must also make a minimum annual payment to the grantor; younger grantors who want to create certain CRTs can have a harder time meeting this minimum payment if rates are too low.
So, in the current low-interest-rate environment, you should consider implementing: 1) intrafamily loans, 2) loans to an intentionally defective grantor trust, 3) gifts through a grantor retained annuity trust, and 4) a charitable lead annuity trust. As interest rates rise, you should consider a qualified personal residence trust and a charitable remainder annuity trust. In either case, it pays to plan ahead for both low- and high-interest-rate environments in these volatile times.
Matthew Erskine is a managing partner at Erskine & Erskine.