Even before people around the world began dealing with the reality of COVID-19, interest rates were at a recent low. For May 2020, the long-term annual AFR rates are as follows: long-term 1.15%, mid-term .58%, and short-term .25%. One common estate planning strategy is the use of Grantor Retained Annuity Trusts (“GRATs”). This strategy is even more effective when interest rates are low.
A GRAT is an estate planning vehicle in which the Grantor (the creator of the trust) places assets in an irrevocable trust in return for the right to receive annuity payments over the term of the GRAT. At the end of the trust’s term, typically the Grantor’s life, trust assets pass to the Grantor’s beneficiaries. The benefit is that any appreciation in the assets transferred out of the Grantor’s estate and into the GRAT will pass to the GRAT’s beneficiaries estate tax free. For this reason, highly appreciable assets should be transferred into the GRAT. The annuity must pay interest out to the Grantor at least at the AFR rate at the time of the GRAT’s creation. When interest rates are low, this strategy is particularly effective. The key is that, over the GRAT’s term, the appreciation in trust assets needs to “beat” the annuity payments out to the Grantor. This technique allows the Grantor to “freeze” the value of an appreciable asset and use their lifetime estate tax exemption based on the asset’s current value, rather than its appreciated value. This can be a very useful tool for those clients who expect to pay estate tax.
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