Navigating the Impact of Rising Interest Rates on Estate Planning

As of November 2023, the Federal Reserve has halted interest rate increases. However, long-term rates have reached 5% [1], and the projected 7520 [2] interest rate is expected to rise to 5.8% in December. Estate planning strategies are highly sensitive to interest rate fluctuations, particularly because the IRS Valuation Tables, which determine the valuation of assets for gift, estate, and income taxes, are linked to the federal funds rate. It’s important to consider strategies impacted by interest rate hikes and those that benefit from them.

Interest rates play a significant role in split interest strategies, which involve different present and remainder beneficiaries. Examples of split interest strategies include private annuities, life estates, term interest remainder interest, and reversionary gifts. The value of both the present and remainder interest in the asset is determined by the IRS Valuation Tables and the Code Section 7520 interest rates, both tied to the federal funds rate. Even small increases in interest rates can have substantial tax implications.

Strategies negatively affected by higher interest rates include private annuities, Grantor Retained Annuity Trusts (GRATs), and Charitable Lead Annuity Trusts (CLATs). In these cases, the grantor gifts the future value of an asset to another party while retaining the right to a current annuity for themselves or, in the case of a CLAT, for charity. With rising interest rates, the annuity rate required to eliminate gift tax or maximize the charitable deduction must also increase.

Strategies benefiting from higher interest rates include Grantor Retained Income Trusts (GRITs) and Charitable Remainder Trusts (CRTs). GRITs for family members are most advantageous when the trust property consists of non-depreciable illiquid assets, such as vacant or agricultural land, artwork, or collectibles. Higher interest rates increase the value of the present interest retained by the grantor and decrease the value of the taxable gift of the remainder interest. Similarly, in a Charitable Remainder Trust, higher interest rates result in the IRS using a higher interest rate to

calculate the assumed rate of return for the trust’s assets, subsequently increasing the payout rate for the variable or fixed annuity retained by the grantor.

Understanding the potential tax implications of various trust strategies under rising interest rates is crucial for effective financial planning. As the anticipated 5.8% 7520 rate approaches, taking proactive measures such as drafting and funding GRITs or CRTs before the year’s end can result in significant tax benefits. Therefore, it is essential to consult with your financial advisor or tax professional to determine the best approach tailored to your circumstances. Don’t wait until it’s too late; take control of your financial future today.

[1] This is the highest the interest rate has been since September of 2007.

[2] Pursuant to Internal Revenue Code 7520, the interest rate for a particular month is the rate that is 120 percent of the applicable federal midterm rate (compounded annually) for the month in which the valuation date falls. That rate is then rounded to the nearest two-tenths of one percent.

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