Estate planning is a complex process that requires careful planning and consideration of various economic factors, including interest rates. This process is the organization of how one's assets and estate will be managed and distributed during their life and posthumously.
When one is looking to organize their affairs, a factor that should be considered is where interest rates lie. As interest rates fluctuate, so do the strategies legal professionals use to help individuals and families seeking to effectively manage their estates.
The impact of high interest rates on estate planning
High interest rates significantly affect the estate planning process, posing varying challenges for individuals and families. Some estate planning techniques are more effective in high-interest-rate environments, while others are less effective. For instance, qualified personal residence trusts (QPRTs) generate a lower remainder interest when the interest rate is higher, resulting in a smaller taxable gift.
On the other hand, using inter-family notes to lend money or sell assets to family members is less advantageous in a high-interest-rate environment compared to a low-interest-rate environment. We are currently seeing the applicable federal rate (AFR) drop slightly, which may influence these strategies.
In a high-interest-rate climate, managing assets such as real estate or investments requires strategic planning. Entities like LLCs or LPs can be used to hold these assets, allowing donors to maintain control while potentially benefiting from valuation adjustments. These adjustments are typically smaller for more liquid assets and larger for less liquid ones.
For appreciating assets, particularly in high-demand markets such as California's real estate, charitable remainder trusts (CRTs) can be valuable as higher rates increase the charitable deduction. Contrary to this, charitable lead trusts (CLTs) are less favorable in such environments.
Grantor retained annuity trusts (GRATs), while ideal in low-interest-rate settings, can still be useful if the assets appreciate at a rate higher than the interest rate, allowing for tax-free transfer of excess appreciation.
Handling existing debts and new borrowing
In a high-interest-rate economy, individuals should be weary of over leveraging themselves. While some may still find current interest rates palatable, it is crucial for those sensitive to debt to consider paying down existing debts. Looking to monitor non-fixed-rate debts is advisable, as well as consulting with advisers about potential refinancing opportunities if rates drop.
Particular industries, such as farming, face unique challenges as they often rely on debt during poor crop years. With declining real estate values, these certain sectors may experience increased financial strain, highlighting the importance of close debt management and avoiding excessive leverage.
Taxes, tools and strategizing in high-interest-rate environments
High interest rates can impact estate taxes, particularly for clients with illiquid assets who may need to borrow to pay taxes. The cost of borrowing in a high-interest-rate environment must be factored into the estate plan. It is crucial to consult a certified public accountant (CPA) to ensure comprehensive planning that addresses potential tax liabilities and liquidity needs.
Estate planning tools such as charitable lead annuity trusts (CLAT), grantor retained annuity trusts (GRAT), and intra-family loans perform differently depending on interest rates. CLATs and potentially GRATs may be less favorable, while techniques involving loans to intentionally defective trusts might still be viable, depending on individual circumstances and calculations.
Ensuring flexibility and realistic expectations is essential, as economic conditions and interest rates can change rapidly. Additionally, building a strategy and plan with a team of professionals can ensure that each client's individual needs are met.
Adjusting long-term estate planning goals
Given rising interest rates, uncertainty about lifetime credit amounts and higher inflation driving asset values, it is crucial to prioritize estate tax planning. Clients should take advantage of the current economic conditions to implement strategies that align with their long-term goals.
Proactive planning and regular review with a team of advisers can help navigate the complexities of estate planning in varying economic climates.
By understanding the impact of high-interest rates and employing appropriate strategies, individuals and families can effectively manage their assets, minimize tax liabilities and achieve their long-term estate planning goals.
Originally published in Sacramento Business Journal
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.