The Federal Reserve’s increasing interest rates have had a significant impact on estate planning strategies in recent years. As interest rates rise, the advantages and disadvantages of various tax strategies also change. Strategies that were once considered beneficial may no longer be as effective in the current interest rate environment. For example, low-interest family loans, which were popular before 2022, are now less attractive due to the higher interest rates that must be charged to avoid negative tax consequences.
Grantor retained annuity trusts (GRATs) have also been affected by the rise in interest rates. While GRATs have been popular in the past, higher interest rates mean that more must be paid to the grantor to avoid tax consequences. As a result, the benefits of GRATs have decreased, making them less attractive as an estate planning tool.
On the other hand, charitable remainder trusts and charitable gift annuities have become more attractive at higher interest rates. These tools pay income to the taxpayer or designated beneficiaries for life or a period of years, with a charity receiving the remaining amount after the income payments stop. Higher interest rates increase the present value of the charitable gift, resulting in a higher tax deduction for the taxpayer.
Charitable lead trusts, on the other hand, have seen a decrease in tax deduction benefits as interest rates rise. This strategy involves a charity receiving income for a set period of years before the property reverts back to the taxpayer or is transferred to a named beneficiary. Higher interest rates have led to lower tax deductions for funding a charitable lead trust.
Qualified personal residence trusts (QPRTs) have become more beneficial as interest rates have risen. In a QPRT, a taxpayer places a first or second home in a trust, retaining the right to live in the home for a period of years before title passes to the trust beneficiaries. Higher interest rates result in a lower value of the gift, making it less costly to transfer the home out of the taxpayer’s estate and into the trust for the benefit of their children.
These strategies, known as split interest gifts, involve the taxpayer retaining ownership or benefits from the property for a period of time before it is transferred to beneficiaries or charity. The values of these interests are determined using current interest rates and formulas issued by the IRS. Estate planners can use software to analyze the tax benefits of these strategies, which are based on the 7520 rates, also known as the applicable federal rates, that are issued monthly by the IRS. Free calculators are also available online to help individuals assess the tax implications of these estate planning strategies in their specific situations.
