Looking to Pass on Assets to Loved Ones? Now is the Time

Is the current uncertainty over estate tax rates keeping you on the sidelines in terms of planning for your heirs? Here’s a summary of the advice I’ve heard from several attorneys: don't worry about it!

Reduced real estate values and historically-low interest rates make this an ideal time to take advantage of several different--and perfectly legal--strategies to pass assets to loved ones with little or no tax consequences.

“My clients are focusing on transferring assets while values are low and getting them out of the estate,” says attorney David Pratt, a managing partner with the firm Proskauer Rose.

Two vehicles that come to mind are GRATs and CLATs, shorthand for Grantor Retained Annuity Trust and Charitable Lead Annuity Trust. In both cases, you (the “grantor”) make an irrevocable transfer property to a trust, which essentially acts as the interim “owner” of the assets.In exchange, the trust must make fixed payments for a certain length of time- either to you, in the case of the GRAT, or to the charity of your choice, in the case of the CLAT. That’s the “annuity” part.

At the end of the trust’s term or upon your death, the assets left in the trust pass to your beneficiaries. (According to Pratt, under current law, the minimum term for a GRAT is 2 years; there is no minimum or maximum term for a CLAT.)

Here’s the key: the minimum amount the trust has to pay out is based on a combination of: 1) the value of the assets you transfer (as of the day the trust is established), and 2) an interest rate set by federal law. The so-called Section 7520 rate is based on current market rates and is adjusted every month.

Why go to all this trouble?  Because if you were to simply give your beneficiaries the property outright, this would be considered a “gift” and you would potentially owe gift tax on the value in excess of $13,000. However,  if the value of the payments the trust makes over its term equals what the assets were worth when you transferred them to the trust, this “zeroes out” the gift.

End result?  No gift tax on the value of the property that passes to your heirs. “To the extent the assets appreciate more than the government rate, they pass tax-free to the family,” says Pratt.

Right now, the Sec. 7520 rate is the lowest it has ever been- 1.8%. (1)

Why is this a good thing?

Because it sets the bar really low. Essentially, the assets in the trust only have to increase by more than 1.8%, which is a pretty low number to clear to pass to your heirs tax free either at the end of the trust’s term or upon your death.(2)

Pratt gives this example: Assume you transfer $1,000 to a GRAT. As the trust creator (“grantor”), you retain the right to two payments of $500 each- the first at the end of Year No.1 and the second at the end of Year No.2.

Theoretically, this wipes out the $1,000 you put into the trust. Since there would be nothing left for the trust to transfer to your heirs at the end of the two-year term, there is no “gift.” Therefore, there is no gift tax.

In real life, however, based on how the money is invested, by the end of Year No. 1 your $1,000 grows to $1,200. After the trust pays you $500, it still has $700.

At the end of Year No.2, the $700 has grown to $900. When your final $500 payment is subtracted, this leaves $400 which passes to your beneficiaries tax-free.

A Charitable Lead Annuity Trust (a.k.a. the Jackie Kennedy Onassis trust) works much the same way except that a charitable organization receives the fixed payments. As a result, the individual who funds the trust receives a charitable deduction. Assets that remain in the trust when it terminates pass to the grantor’s beneficiaries.

A low interest rate environment also makes other estate techniques attractive.  These include self-canceling installment notes, intra-family loans, and the sale of assets to a “defective” grantor trust.

The bottom line?  Don’t let political gamesmanship in Washington put your estate plans on hold.Or, in Pratt’s words, “Forget all the hype about what the rates and exemption amount will be.”After all, if you can move assets out of your estate, why should you care what the estate tax rate is?

1. When it was introduced in May 1989, the Sec. 7520 rate was pegged at 11.6%. It never hit this level again. It was in the range of 6-9% for much of the 1990s. It fell below 6% for the first time in 2001. From 2002 through 2008 it ran between 3.0% to 6.2%. It dropped to 2.0% in February 2009 and inched up to 3.2% by December. As recently as last May, it was at 3.4%.

2. According to Northern Trust, one downside of a GRAT is that if you die before the trust’s term is completed, the assets in the trust will be included in your taxable estate.

Ms. Buckner is a Retirement and Financial Planning Specialist at Franklin Templeton Investments. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content.