Planning in Volatile Markets

Market volatility and rising interest rates present estate planning opportunities. For example, consider depressed market values as a natural “discount” without having to use complicated structures to generate valuation discounts. The seven techniques highlighted below provide opportunities to transfer additional wealth to loved ones and charities.

1. Grantor-Retained Annuity Trusts (GRATs)

GRATs can transfer wealth free of estate, gift and income taxes. They involve funding a trust while retaining an annuity payment of principal plus interest. Growth over the interest rate transfers tax-free to beneficiaries.

Three insights:

Monthly, the IRS publishes the Section 7520 interest rate, which is rising but remains below historical averages. Establishing a GRAT now captures the current rate.

Imagine market disruptions push a $100 per share stock to $70 per share. If a GRAT is funded with the stock at $70 and it reverts to $100 before the end of the GRAT term, the $30 per share increase (minus the Section 7520 interest rate) transfers tax free to the beneficiaries.

For existing GRATs with undervalued assets, consider a tax-free swap of a low-volatile asset (e.g., cash). Next, use the retrieved undervalued assets to fund a new GRAT, where recovery of the assets benefits the beneficiaries.

2. Basis Management with Grantor Trusts

Many irrevocable trusts are completed gift grantor trusts, meaning trust income is reported on the grantor’s tax return and the assets are outside the grantor’s estate. However, there is no basis adjustment (step-up or down) on trust assets at the grantor’s death.

Thus, consider whether a) higher potential growth assets should be swapped into the trust, or b) lower basis assets should be swapped out of the trust, positioning for basis adjustment at death.

3. Traditional Individual Retirement Account (IRA) Conversions

Tax law permits conversion of Traditional IRAs to Roth IRAs, gaining more favorable tax treatment, which is enhanced in volatile markets. Why? An individual includes in income the value of the Traditional IRA assets on the conversion date. When the market forces values lower, less income tax is triggered. Further, after five years, Roth IRA distributions and gains are not taxable.

4. Alternate Valuation

Alternative valuation permits paying estate tax on asset valuations six months after the date of death (AVD) instead of on the date of death, when electing decreases both the value of the gross estate and the combined amount of federal estate tax and generation-skipping transfer (GST) taxes.

If the value of a decedent’s portfolio drops after the date of death but is expected to recover before the AVD, consider selling it, as the sales price applies.

If the estate plan incorporated formula transfers that avoid estate tax, the test is failed because no estate tax is due. Consider disclaiming a small amount or exercising a partial Qualified Terminable Interest Property (QTIP) Trust disclaimer to generate a modest estate tax, thus enabling the use of AVD and reduce estate taxes.

 The basis adjustment rules provide that if alternate valuation is elected, one uses the AVD value. Meaning, analyzing the impact on basis to beneficiaries may be appropriate.

5. Low Interest Rate Intra-Family Loans

Generally, tax law requires loans be made with a minimum interest rate to avoid imputed income or gifts. Known as Applicable Federal Rates (AFR), the minimum rates are established monthly but can be fixed for term loans.

Like term marketable debts, AFRs are rising but remain below historical averages. Here are planning examples taking advantage of fixed AFRs:

• Loan money to children or grandchildren
• Loan money to a grantor trust as interest paid is not taxable income (consider using a GSTT tax exempt trust)
• Refinance a loan to reduce the rate or extend the term
• Sell assets to a grantor trust in exchange for a promissory note

6. Annual Exclusion Gifts

An individual can give up to $17,000 annually per recipient, without using one’s estate, gift or GST exemptions.

Some make gifts at the beginning of the year, so appreciation during the year is outside their estate; others wait for the year-end. Consider giving when assets suffer down valuations. The growth reflecting the return to normal values directly benefits the recipient at no tax cost. Alternatively, give cash and allow the recipient to invest and capture the return to normal valuations.

7. Enhanced Exemptions

Current law permits a $12,920,000 exemption for estate, gift and GST taxation ($10 million base, indexed to 2023). The law that doubled the exemptions expires December 31, 2025.Absent a law change, the exemptions will return to $5,000,000, indexed from 2017.

With the uncertainty of the exemption amount, wealthy individuals should consider using their full exemptions, particularly with assets depressed in value. Thus, removing assets and appreciation from their taxable estate.

Conclusion

Market volatility and rising interest rates are unsettling but create estate and income tax planning opportunities for loved ones.

           

This article is provided solely for informational purposes and is not intended to provide financial, investment, tax, legal or other advice. It contains information and opinions which may change after the date of publication. The author takes sole responsibility for the views expressed herein and these views do not necessarily reflect the views of the author’s employer or any other organization, group or individual. Information obtained from third-party sources is assumed to be reliable and has not been verified. No outcome, including performance or tax consequences, is guaranteed, due to various risks and uncertainties. Readers should consult with their own financial, tax, legal or other advisors to seek advice on their individual circumstances.