Creating an Estate Plan When Interest Rates Are High

In 2022, the Federal Reserve hiked the federal funds rate several times, which resulted in interest rates increasing by a considerable amount. Interest rates for a 30-year mortgage are just over 6% at the moment, which is much higher than the low of 2.65% that was reached in January 2021. While the Federal Reserve is expected to reduce the number of rate increases that occur in 2023, interest rates will likely remain high for the foreseeable future.

Consider Charitable Remainder Trusts

When interest rates increase, estate planning strategies that worked in a low interest-rate environment may no longer be as effective. For instance, charitable lead trusts are regularly used when interest rates are relatively low.

When using this strategy, the value of income and any remainder interests are estimated with the interest rate. The same calculation occurs when placing money in a charitable remainder trust. The difference between these two trust accounts is how interest rates impact the charitable deduction that can be claimed on an annual tax form.

In a charitable lead trust, a higher interest rate leads to less value for the income interest that passes over to the charity, which means that the charitable deduction for the year will also be smaller.

In comparison, a high interest rate in a charitable remainder trust should result in more interest being passed over to the charity, which leads to a higher charitable deduction. Transferring assets directly to a charitable remainder trust will get rid of high capital gains taxes as well.

Look Into QPRTs

Qualified personal residence trusts (QPRTs) haven’t been used much in previous years because of the low interest-rate environment. Now that interest rates are higher, this technique may be viable for transferring wealth. A QPRT provides people with the ability to transfer a home at a lower value while they continue to live there for years to come.

The interest rate determines how much interest the individual will retain in their residence. When interest rates are high, people can retain more value, which means that the taxable gift provided to beneficiaries is smaller. This technique is commonly used by individuals who hold most of their wealth in residential properties.

An Inflationary Environment Results in Higher Exemptions

Now that 2023 is here, the high inflation that started in 2022 means that people can claim certain tax exclusions and exemptions when filling out their annual tax forms. The lifetime transfer tax exemption has increased by $860,000 this year, which is the highest adjustment ever made. It’s now situated at $12.92 million.

Keep in mind that the annual exclusion for gift taxes is also increasing by $1,000 to a total of $17,000. Taking advantage of these latest increases makes it possible to provide gifts to friends or family members without needing to pay a transfer tax. If you’d like to learn more about how your estate plan can impact taxes for yourself or beneficiaries, our New Jersey estate planning lawyer can answer any of your questions.

GRATs Aren’t Solely Used With Low Interest Rates

A grantor-retained annuity trust (GRAT) is an estate planning strategy that’s typically used when interest rates are low. However, it’s also effective for transferring wealth when interest rates are increasing. The outcome of a GRAT depends on if the value of assets within the GRAT appreciate at a rate that’s higher than the interest rate. All extra appreciation will be sent to the estate plan’s beneficiaries as a tax-free gift.

GRAT accounts can also be used as zeroed-out GRATs, which indicates that any money transferred to the GRAT won’t reduce the individual’s gift tax or transfer tax exemption. If someone has assets that they believe will increase significantly in value over the next few years, the GRAT strategy could still be put into place even when interest rates are high.

A GRAT is also considered to be a risk-free strategy. In the event that it fails because the assets appreciate at a rate that’s lower than the interest rate, there aren’t any economic or tax issues that occur. In this scenario, the only consequence is that transaction costs will be lost. GRATs are an appealing estate planning strategy for people who don’t want to take on too much risk.

If you’d like to seek legal guidance that will help you craft an effective estate plan, call our Hackensack, New Jersey estate planning lawyer today at (201) 996-1200 to schedule a private consultation.