First and foremost, my thoughts are with those impacted by COVID-19. This has been a challenging time, and some are facing greater challenges than others. I hope brighter days are ahead. Alas, the economic headwinds we are facing have caused investment markets to swoon and the Federal Reserve to lower interest rates to near zero. For those who have the means, stock market volatility and low interest rates create estate planning opportunities. Here are four examples:
1. Grantor Retained Annuity Trusts
Grantor Retained Annuity Trusts (GRATs) are an effective strategy for transferring wealth to the next generation. A GRAT involves the grantor (usually the parent) transferring wealth into a short-term irrevocable trust (2-10 years for example) while retaining an annuity repayment of most or all of the principal. When the GRAT term expires the leftover asset is the beneficiaries. The IRS assumes that the trust assets will generate a return based on a predetermined interest rate, the Sec. 7520 rate. Think of the 7520 rate as a hurdle, any appreciation beyond the 7520 rate passes to the beneficiary. GRATs are especially attractive right now, given the 7520 rate is so low. The August 2020 7520 rate is .49%. A GRAT is an excellent way to gift to the next generation with potentially little to no gift tax.
2. Low-interest-rate Loans
Do the kids need money for a house or a business? Instead of giving the money outright, family loans are an option. Tax code requires most loans be made with a minimum amount of interest, the "applicable federal rate" or AFR. As you might have guessed, AFRs are quite low now. Family loans are good if you want your child to have some "skin in the game" or want your child to be responsible with the funds. I encourage you to speak to a qualified professional beforehand, as a properly structured family loan requires a repayment schedule, appropriate interest rate, and other details.
3. Gifting stock
If you have securities in your portfolio that may have lost value, gifting those shares to your child may make sense. Any appreciation in the future is in the child's estate, not yours. Or you might be inclined to gift stock that has a low tax-basis. This way if your son or daughter sells the stock, they do so in their tax bracket, not yours. (Assuming your children are in a lower tax bracket and they file their own tax return.) You must weigh this with the "step-up in basis" rule, where children can inherit stock with a date of death value. This may cause less of a tax headache when they sell.
Gifting stock has non-tangible benefits as well. I have a client who gifts his son small amounts of various stocks. They regularly communicate with each other about the stock's growth prospects and whether to keep or sell. Both find it time well spent, except when the other is right.
4. Roth Conversions
If your IRA has lost money due to market volatility and you envision being in a lower tax bracket in the future, converting a traditional IRA to a Roth may make sense. The drawback is the full amount of the IRA converted is included in your taxable income. For those in a high tax bracket, that is a major disadvantage. I find running the numbers and seeing how converting to a Roth or not impacts a retirement over time helps. For some, the numbers bear it out - a conversion makes sense while for others the crossover point may never be reached.
Market volatility and lower interest rates may be unsettling for some, but for the right investor, the estate and financial planning strategies mentioned here represent an opportunity to make lemonade out of lemons.
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