Looking for a stimulus package for your estate plan?

Lately, news about the economy has been downright depressing. But like most problems, the current economic woes also present some extraordinary opportunities. One of these involves estate planning: Low interest rates combined with depressed stock and real estate prices make it an ideal time to transfer wealth to your children or grandchildren.

Hunting for bargains

This year, the federal estate tax exemption is $3.5 million, up from $2 million in 2008, and the lifetime gift tax exemption remains at $1 million. The annual gift tax exclusion is now $13,000 per recipient (up from $12,000 in 2008) or $26,000 for gifts you split with your spouse.

As of this writing, the estate tax is still scheduled for repeal next year. But that’s unlikely to happen. Congress is expected to retain the estate tax along with the current (or possibly higher) exemption amounts. Check with your estate planning advisor for the latest information.

The higher exemption and exclusion amounts increase the potential benefits of making gifts to your children and other family members of assets whose values have declined, such as stock or real estate. These gifts allow you to maximize the amount of wealth you can transfer tax free while minimizing the value of taxable gifts. Plus, any future appreciation that these assets will enjoy when the economy rebounds will go to your beneficiaries free of gift and estate taxes.

Gifting now can pay off later

Outright gifts aren’t always the most effective way to transfer your wealth. If your net worth is large enough, direct gifts may trigger an enormous gift tax bill, even if asset values are depressed. And regardless of the tax implications, you may not be ready to relinquish control over your wealth.

Under these circumstances, you may wish to use trusts, family loans, installment sales or other arrangements that provide your children or other beneficiaries with future benefits. And with interest rates at their lowest levels in years, now is the time to take advantage of these techniques.

Consider the family loan, for example. To avoid gift taxes on a loan to your child or another family member, you need to charge interest at or above the applicable federal rate (AFR). Recently, the AFR has been as low as under 2% for midterm loans (three to nine years) and just below 3% for long-term loans (more than nine years). Check with your estate planning advisor for the current rates.

If you lend money to your child, who then invests the funds in assets that outperform the AFR, he or she will have a substantial amount of money left over after paying back the loan. In other words, you will have made a sizable tax-free gift.

Using GRATs to your advantage

Another powerful estate planning tool in a low interest rate environment is the grantor retained annuity trust (GRAT). A GRAT is an irrevocable trust that pays you an annuity during the trust term and then distributes any remaining assets to your children or other beneficiaries. Your contributions to the trust are treated as taxable gifts to your beneficiaries, but the value of the gift is limited to the present value of the remainder interest.

To calculate the gift tax value, the present value of the annuity payments is subtracted from the value of the assets you contribute to the GRAT. Present value is based on a conservative, assumed rate of return commonly known as the Section 7520 rate. At the time of this writing, that rate, which is published monthly by the IRS, was at its all-time low of 2.4%.

If you set the annuity payments high enough or the trust term long enough, you can minimize the value of the gift for gift tax purposes or even reduce it to zero. And so long as the trust assets outperform the Sec. 7520 rate (and you survive the trust term), your beneficiaries will receive a substantial amount of wealth at the end of the term, free of gift and estate taxes.

GRATs are an attractive option when interest rates are low because it’s easier to outperform the Sec. 7520 rate, maximizing the amount of wealth you can transfer tax free. And if you fund a GRAT with assets whose values are depressed and are expected to appreciate significantly in the future, the benefits a GRAT provides are that much greater.

Act now

These are just a few of the estate planning options available that take advantage of low interest rates and depressed asset values to cost effectively transfer wealth. Other options include installment sales, intentionally defective grantor trusts and charitable lead annuity trusts.

Whichever strategy you choose, it’s important to move quickly. Although these estate planning tools are valuable in good times as well as bad, they will lose some of their potency as the economy recovers. •

Will Congress slash valuation discounts?

Looking for another reason to transfer wealth to your beneficiaries sooner rather than later? (See main article.) Congress is considering legislation that would limit the availability of certain valuation discounts for gift and estate tax purposes when intrafamily transfers are involved.

For example, many parents establish family limited partnerships (FLPs) to transfer wealth to their children. They transfer assets, such as stock or real estate, to the partnership and then transfer limited partnership interests to their kids.

If an FLP is structured and operated properly, the family can enjoy substantial gift and estate tax savings. Why? Because minority FLP interests generally are entitled to valuation discounts for lack of control and lack of marketability. As a result, a limited partner’s interest may be worth significantly less than his or her proportionate share of the partnership’s asset values.

In a report published last year by the Joint Committee on Taxation, lawmakers proposed reforms that would limit the ability of families to take advantage of valuation discounts to reduce gift and estate taxes. It’s not yet clear what Congress will do, but any reforms it makes will likely apply prospectively only, so it pays to get your estate plan in order now.