- The down market is an opportunity for the rich to save on estate taxes by giving away depressed assets.
- But rate hikes eat into the profits of the most popular trusts used to transfer wealth.
- The rich are now giving millions to take advantage of an expiring Trump tax cut.
Wealthy Americans have dodged almost every tax hike proposed by the Biden administration and Democratic senators. But we are nearing the end of a Trump administration tax cut that allowed the rich to give away twice as many millions without paying estate taxes.
Currently, individuals and married couples can give or inherit $12.06 million and $24.1 million, respectively, before a 40% state estate tax applies. However, this exemption is set to increase to $5 million per person, adjusted for inflation, by the end of 2025 as of 2018.
Wealthy taxpayers, including media mogul Michael Bloomberg and Blackstone’s Stephen Schwarzman, often use trusts to avoid estate taxes, according to ProPublica. The market slump is a prime time to start new trusts as people can transfer depressed assets to a lower tax base.
Trump’s tax cuts, depressed assets, and rising interest rates have created a near-perfect storm for one of the most popular types of trusts, grantor-retained annuity trusts (GRATs). Over the past two months, Bank of America’s private banker Katie Carlson has noted that more customers will soon want to give gifts before interest rates get even higher.
“This environment of rising interest rates has been a catalyst for planning,” said Carlson, head of wealth strategy. “It is not really to be expected that interest rates will go down. With many of these types of trusts, there are advantages to having lower interest rates.”
GRATs typically last two years and pay a fixed annuity to the trust creator (or grantor). Provided the grantee survives the trust, the beneficiaries receive the appreciation of the property and there is no inheritance tax. But in order to make a profit, the assets must grow faster than the rate of return assumed by the IRS.
This 7520 rate, which is set monthly and named after a tax revenue code, has skyrocketed due to rate hikes, making it harder to earn income from GRATs. The current rate is 3.8%, more than double January’s rate. In the fall of 2020, the 7520 rate was just 0.4%.
“Back in 2020, you could throw in anything, high-yield performance bonds, a very conservative stock portfolio,” said Eric Mann, a partner at Neal Gerber Eisenberg. “But when interest rates rise, you need an asset with more volatility and more potential for growth to break that hurdle.”
Why the market slump is a prime opportunity to save on estate taxes
There is additional pressure to back down now while the market is down. BNY Mellon Wealth Management’s Jere Doyle has seen clients achieve big tax savings by investing depressed assets in GRATs during recessions. For example, during the 2008 financial crisis, a client invested $5 million in bank stocks in a GRAT that tripled in size in a year. The $10 million in winnings were not included in his estate tax exemption.
“Valuation is the name of the game,” said Doyle, senior vice president and estate planning strategist. You want to take things from your estate while their value is low so that when their value goes up, they belong to your children and not yours. It’s like a home run.”
Grantors can convert assets into GRATs as long as they are of equal value. Mann said now would be an advantageous time to trade into highly volatile assets like cryptocurrencies.
Estate planners encourage clients to take advantage of this market and higher tax exemption. But some customers are reluctant to give tens of millions to their children while they are still alive.
Married taxpayers can get around this problem by using Spousal Lifetime Access Trusts (SLATs), said Robert Strauss, a partner at Weinstock Manion. Essentially, a person places assets in the trust with their spouse as beneficiaries and sometimes their children as additional beneficiaries. The person has indirect access to the trust property and the spouse can even claim distributions from the trust with the consent of the trustee if they encounter financial problems in the future.
Clients typically do this because giving away enough millions to use all of the estate tax would cost a significant portion of their net worth or because they want control of the wealth, Strauss said.
“I have a $300 million client who felt he couldn’t afford to give gifts to benefit his children and wanted to retain access to all of those assets,” he said. “I found that it has nothing to do with objectivity.”