Asset Declines=A Planning Opportunity - Part 2


Last week we discussed how today’s economic distress creates estate planning opportunities. Because of today’s reduced asset values, estate owners can shift assets out of their estates tax at much lower tax cost than they could have a year or two ago. We went over basic strategies for taking advantage of the situation. This week, let’s look at ways to leverage these strategies.

Family loans. Many families like the concept of loans to family members. If you might need the money in the future, a loan lets you provide benefits to family members now while retaining future access to the wealth. The IRS requires you to charge a minimum interest rate on a family loan to avoid income and gift taxes. The minimum rates are based on treasury debt rates. Because the Federal Reserve has been pushing down short-term rates and investors have been reducing intermediate and long-term rates in the flight to safety, the required minimum rates are low. The rates are changed monthly, and depend on the loan's maturity or term. They are known as “federal applicable interest rates” and are published monthly by the IRS in its Internal Revenue Bulletin.

Family loans are very flexible, but here is how one common strategy works. You lend $100,000 to a child for five years. Let's say the law requires you to charge 2% interest. Your child can invest that money for five years. If the investments earn more than 2% annually, the child keeps that excess return. You receive the $100,000 plus 2% annual interest after five years.

Alternatively, you could lend the money to allow a child to buy a home in today's depressed market. You might set the term of the loan at 10 years. There are several actions the child could take by the end of 10 years. The home could be sold at a profit, with the child keeping the return above the interest rate you charge. Or once the credit markets loosen, the child could refinance the home with a traditional mortgage and return the borrowed money plus interest to you.

The benefits of the family loan can be increased with a variation. If you do not need the money to maintain your standard of living, each year you can use the annual gift tax exclusion to forgive the interest and part of the principal. This shifts the money and future appreciation out of your estate tax free over time while enabling your children to benefit from having the cash now.

In some circumstances a minimum interest rate need not be charged on a family loan if the principal is low enough. I won’t go into the details here. They are available in the members’ section of my web site at and also from

Grantor retained annuity trusts. Today's low interest rates make these trusts a potentially great opportunity.

The grantor creates a trust that pays a fixed income to him for life or a period of years. After that the remainder of the trust goes to the beneficiaries. The present value of the remainder is a gift. The present value is determined by IRS tables, and current interest rates are a factor in determining the amount of the gift. The lower the interest rates, the smaller the value of the gift. If the return actually earned on the asset exceeds the IRS interest rate, the excess becomes a tax-free gift to the heirs.

A GRAT should be created with assets that are expected to appreciate rapidly within a few years or earn high income. Studies show value is maximized by creating a GRAT to last two years. After the trust expires, consider creating a new trust with different assets.

Charitable trusts. If you are inclined to make significant charitable gifts, consider making them now through a charitable trust. In particular, charitable lead annuity trusts are most advantageous when rates are low.

The CLAT pays income to a charity for a period of years. The payments are either a percentage of the trust’s value or a fixed annual amount. After the income period expires, the remainder in the trust goes to the other beneficiaries, usually the children of the trust creator.

The present value of the remainder for the children is a taxable gift when the trust is created. Again, because of today's low interest rates the taxable gift will be less than at other times. In addition, the combination of low interest rates and low asset values create the potential that the appreciation of trust assets will significantly exceed the income paid to the charity and the amount on which gift taxes were paid. The result could mean a significant amount of wealth is transferred tax free to heirs.

The creator of a CLAT can take a tax deduction for the present value of the gift to the charity. Doing so, however, obligates him to pay taxes on the income and gains of the trust. Foregoing the deduction avoids the taxes on the income and gains. The CLAT is irrevocable. Once created, you cannot get the money back or change the terms of the trust.

Today's low interest rates and decline in asset values present estate planning opportunities. Some of these are straightforward and easy to implement. Others, such as trusts and family loans, should be done only with the help of a tax or estate planning expert. Once the current crises end, the benefits from making the moves now could be significant.


Bob Carlson is editor of the monthly newsletter and web site Retirement Watch at He also is the author of The New Rules of Retirement and Invest Like a Fox…Not Like a Hedgehog.

Posted 02-20-2009 11:46 AM by Bob Carlson