Now is the right time to reduce future property taxes

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The IRS’s historically low interest rates make this a great time to use one of my favorite family wealth transfer vehicles – Grantor Retained Annuity Trusts (FREE).

FREEs are a well-established estate freeze and giving strategy to reduce future estate taxes by transferring assets to your beneficiaries (children) without using the lifetime gift tax exclusion. Basically, a FREE is a newly created trust that is funded by the settlor in return for a stream of annuity payments, over a predetermined period of time, at a predetermined interest rate (the “rate of 7520”, after its termination. code section). After the final annuity payment is made, whatever remains in the trust is transferred to the designated beneficiary (eg children). As a general rule, the Libres are “reset”, which means that the amount paid to the trust is equal to the present value of future annuity payments to the settlor and therefore does not give rise to a donation.

This vehicle is particularly attractive in the current context of extraordinarily low interest rates. The IRS 7520 rate is currently 60 basis points (0.6%). This is the interest element built into annuity payments, which is the investment threshold that must be exceeded for the FREE to leave residual interest. (In a 2012 column, I recommended FREEs when the 7,520 rate was 1.4%.)

The above highlights the key requirement for a successful FREE. there must be residual interest to distribute. But what if the value of the invested assets does not exceed the 7,520 rate, or the investments decline? There is really no downside risk other than professional fees; the trust distributes the remaining assets to the settlor. If the settlor dies during the life of the GRAT, then the assets revert to his estate as if the trust never existed.

The strategy when planning with the FREEs is to capitalize on their very favorable quality of creating donation-free transfers of net investment gains, without being penalized for net investment losses. To increase the likelihood of wins, we tend to set up multiple FREEs at the start, each invested in a different asset class. We can use investments already held by the grantor, such as domestic and international stocks, more aggressive fixed income securities and for business executives, perhaps company stocks. The hope is that at least some asset classes will rise in any given market. Sometimes we “freeze” a FREE before its final distribution when there are large wins that we want to lock in, or if there are losses so large that there is little likelihood of a gain during its term. . We do this by swapping the investments and replacing them with other assets in the grantor’s portfolio, such as cash equivalents or bonds. Often times when a particular asset class has been hit hard, again we can replace the investment and then set up a new FREE that will have greater upside potential.

FREEs are elegant estate planning vehicles and the tax laws around them are both very taxpayer friendly and very demanding; there are tax rules that must be strictly followed. The estate attorney who drafts the trust, and perhaps a separate trust for residual interest, can provide specific recommendations to the client. In addition, it is advisable to ask your financial planner or investment professional who understands the nuance of FREEs to help you choose assets for initial funding and to optimize the ongoing management of FREEs.


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