What’s the Upside in a Downturn? —Today’s Environment Has Created Once-in-a-lifetime Wealth Planning Opportunities

By Nicholas J. Bertha


When interest rates and asset valuations fall together, the result for some is an unprecedented  planning window.

Today, as a consequence of the Coronavirus and the resulting market and policy responses, we are seeing both. Here we will share the effects of this on some common planning techniques. Let’s start with rates.

While you are probably well aware that today’s low interest rates have put a wet blanket on what you can earn, you might not know that those same rates have poured the gas on what you can gift.

We are referring to something known as the “Applicable Federal Rate” or AFR, and its equally little-known cousin, the “7520” rate. These rates help determine whether certain wealth transfer strategies will have the desired tax benefits. When they are low, it’s good for gifting, and they are very, very low.

For one wealth transfer strategy this means that the level of assets that could be available to transfer estate and gift tax free is significantly higher than it would have been (or will be) in a higher interest rate environment. For another, it means that it is easier to make annuity payments to charities and also gifts to children, while paying little or no gift tax.

Clearly, hard times for fixed income returns are high times for wealth transfer strategies.


Let’s give this a sense of proportion. The “mid-term” AFR was near 12% in the ‘80s. At the end of 2006 it was 4.75%.  In May, 2020 it will be just 0.58%.  The “7520” rate was almost 14% in the ‘80s. By 2006 it was 6.0%. Today it is 0.80%!

Yet, beyond that, these surreal economic times are creating wealth transfer opportunities in another way. There have been, and continue to be, great fluctuations in value across a broad spectrum of asset classes. The most obvious is the stock market, but it is also true for valuations that can be obtained for small businesses, real estate and, in particular, oil and gas related properties. For many of the techniques discussed in this paper, the greatest amount of wealth that can be passed to younger generations is the amount of the current discount that may be taken on assets that could appreciate in the future.

Some of the more compelling strategies in this environment come cloaked in some of the most opaque acronyms: GRATs, CLATs, IDGTs, along with blissfully self-explanatory Intra-Family Loans.  Let’s take a look, but first a digression. Someone once said, “The estate tax is a voluntary tax; you can pay it, or you can plan around it.” There is much truth in that, but one has to take advantage of opportunities as they present themselves. There are opportunities here, but as the automobile companies say about the summer sales, “They won’t last forever.”


Grantor Retained Annuity Trusts (GRATs)

A GRAT is a planning technique engineered specifically for wealth transfer, and it works best when interest rates and asset valuations are low but expected to have significant growth in the near/mid future. It makes it possible for you to, in essence, gift that future growth (say, a concentrated position in stock) to your children[1] free of gift and estate tax, while at the same time returning the initial value of that asset as an annuity stream to you over time. In these current times of great market volatility, with certain industries and assets under what one hopes is only short-term duress, this technique could offer interesting opportunities.

In other words you can have it both ways, retaining the value of an asset, even as you have given away all future appreciation associated with it as a gift.

Here’s how it works. You make a gift of the asset to a trust, usually short term in nature, and decide on an investment plan for those assets. The trust, as mentioned, includes a mechanism that returns to you – in its most popular form, known as a “zeroed-out GRAT” – the amount of your original gift (the principal) as an annuity over the term of the trust. Throughout this time, the asset will – with good planning and some good fortune – appreciate in value, and that growth will later transfer to your children or whomever you’ve named as beneficiary.

Consider a parent who, as a strategy to transfer wealth to a child, gifts $5 million of securities (or any other asset) that is expected to experience meaningful short/medium-term growth to a zeroed-out GRAT. The GRAT will have a 5-year term, a 10% growth rate and will distribute back the full $5 million (plus the required 7520 “hurdle rate”) in equal annual installments to the parent. (If you make graduated payments – each annual payment up to 120% larger than the previous year’s – you may see an even more attractive result.)

Assuming the growth rate is achieved, by the end of the GRAT term the parent will have received back $5,120,640, and $1,800,146 will be left as the gift and estate-tax-free transfer that would go to children (or a trust for their benefit). Had the 7520 rate been 6%, the ultimate transfer to the child would have been only $805,970.

For illustrative purposes only. The above is not a forecast or promise of investment performance, but an example of the impact of a trust strategy under different interest rate scenarios.

There is a “but,” however: tax law requires that you not only take back what you contributed, but also an additional percentage. That percentage is the aforementioned 7520 rate. The lower that rate, the less you have to take back as an annuity; the less you have to take back as an annuity, the more that remains to transfer to your children free of gift and estate tax. For this reason the 7520 rate is often referred to as the “hurdle rate.”

And, it’s important to realize that there is really no downside: if the assets transferred into the GRAT don’t appreciate, their initial value is simply returned to the grantor by way of the annuity payments. There is only one caveat, generally adhered to without complaint: you must outlive the term of the GRAT for it to be effective.

As a real-life example, we are currently working with clients from energy-producing areas of the country who own significant interests in oil-producing properties, with large taxable estates. One, in Texas, had been considering creating a series of short-to medium-term GRATs as part of her overall estate plan, but now, given the historical disruptions in energy prices, has put the project on fast forward. There are also, of course, many people holding the equity securities of solid companies that are dramatically off their highs.


Charitable Lead Annuity Trusts (CLATs)

If you want to place an asset in trust for your children, but don’t personally need or want to draw an annuity from it, you may like the idea of that asset providing an annuity to a charity instead. In a way, you might think of a CLAT as a charitable GRAT, with some beneficial twists.

Here’s how the CLAT works. As with a GRAT, you set up a trust and, working with your advisors, decide on the number of years for its term, set up an investment plan, and calibrate the rate at which the trust will pay an annuity stream to your chosen charity. If you plan well and your investments cooperate, at the end of the trust’s term a substantial asset will remain for your children.

A low 7520 rate is the great enabler. In taxing the future gift to your children, the IRS does not care what level of assets ultimately remains for them. Any gift tax is based on a present value calculation of the annuity that will be paid to the charity over time, the discount factor is determined by the 7520 rate. The lower that rate, the lower the discount factor, and the higher the IRS will value the charitable gift – potentially high enough to show a zero remaining gift to your children. Meanwhile, to the degree that the assets are able to outperform the rate at which they are being annuitized as the distribution to charity, the potential exists to leave a tidy sum to your children.

Also the trust can be structured so that the contribution creates a charitable deduction at the time of the gift; although the earning of the trust would then be taxable to you.

Now our parents have decided to take another tack and create a $5 million CLAT to last 25 years. It will pay an annuity to their favorite charity of just under $240,000, and all remaining assets in the trust, when its term ends, will go to their children. Assuming the trust could earn 7% on invested assets, there would be more than $13 million distributable to the children, free of transfer tax. This is because the discounted present value of the total annuity payments to the charity matches the original gift to the trust, thanks to the low 7520 rate. That ability is the power of this technique.  If the 7520 rate had been 6% as opposed to the current 0.80%, in order to achieve the tax-free transfer the total gifts to charity would have to have been over $390,000 per year and just under $2.4 million would be left to distribute to children. For illustrative purposes only. The above is not a forecast or promise of investment performance, but an example of the impact of a trust strategy under different interest rate scenarios.  


Sales to Intentionally Defective Grantor Trusts (IDGT)

For many wealthy families, the lifetime gift tax exemption will cover only a fraction of the assets that will eventually be transferred, so a great deal of effort goes into techniques that will move assets out of the taxable estate without relying on this exemption.

Enter the hyper-technically named intentionally defective grantor trust (IDGT), a strategy that works somewhat like a GRAT, but is more flexible. The IDGT does not overly rely on your gift tax exemption because, technically, you are not “gifting” the assets. Instead you are setting up a trust and selling the assets into it. In return, the trust compensates you with a promissory note entitling you to a stream of payments, the size and duration of which you will have calibrated with your advisor.

This stream of payments must include interest, and here our friend the AFR makes another appearance. The AFR establishes the minimum interest payment, so the lower the rate, the less interest is paid out, leaving more remaining in the trust for your children.

At the time you sell the assets into the trust, the assets are frozen as a result of the promissory note. Any appreciation above the “freeze level” transfers to your children and is not subject to gift and estate tax.

The trust is deemed “defective” because the Internal Revenue Code does not see it as a separate income taxpayer, so while income earned in the trust is taxable to you, interest on the installment payments and any capital gains on the sale of the property to the trust are viewed simply as payments to yourself, therefore not taxable.

While an IDGT lets you remove assets from your estate with minimal reliance on your lifetime gift tax exemption, it also lets you take advantage of an exemption that extends beyond your lifetime – the generation-skipping tax (GST) exemption. A Dynasty Trust could be an ideal beneficiary of this strategy.

And once again, in this period of fantasyland for asset values, this strategy could be opportune.


Intra-Family Loans

The final planning strategy we will review is the simple case of loans between family members. If you like the benefits of an IDGT (bypass lifetime gift exemption, freeze the taxable value of the asset), but can live without the GST exemption and the complexity of establishing a trust, this technique will hold some appeal.

The technique typically involves the sale of an asset from a wealthier, older family member to a younger, less wealthy family member. Like an IDGT,  it is technically an asset sale, in this case to a family member, in exchange for an installment note. While there are many reasons people use this strategy, for our purposes here we will view it as an alternative to other gifting techniques.

Like an IDGT, an intra-family loan freezes the taxable value of the asset at the time of the sale, keeping future growth out of your taxable estate. Though the family member who “gives” the note (let’s assume an adult child) must pay interest, they benefit from now owning an asset whose value has the potential for significant growth. Here, the appeal of low interest rates is obvious. Your child will pay less interest in exchange for the asset, and therefore (assuming the assets transferred can grow faster than the interest rate on the loan) will net a more generous transfer than would otherwise be the case.

Unlike an IDGT, it is a relatively simple technique to implement, but it does not offer the more powerful benefits of a trust, like dynasty provisions, asset protection, etc.

An interesting variation of this is the self-cancelling installment note or SCIN, where the note is terminated in the event of the death of the seller, let’s again assume the parent. As a wealth transfer tool, it can be effective, for example, in cases of terminal illness, where the seller’s actual life expectancy is less than their actuarial life expectancy. The structure requires the buyer, or child, to pay interest in excess of market rates, or a premium for the asset (to compensate the seller for “termination risk”). If structured properly, there is no gift tax at the time of the transaction and, importantly, the value of the note is not included in the estate of the seller should he or she pass away before the note is paid off. The risk here is that the note will come to full maturity and more will have been paid and received than had a standard installment note been used.


These are times of historically low interest rates and highly volatile asset values. In the estate planning world they present unique, arguably once-in-a-lifetime, opportunities. Moreover, the estate tax is, as we said earlier, largely a voluntary tax. You can pay it, or you can plan around it. Here we have outlined a number of planning strategies that are particularly attractive in the current environment.

Interest rates will go up and estate tax laws will change. In fact, should Joe Biden, the presumptive Democratic nominee for president, get elected, he is proposing to tax unrealized capital gains on many assets at death or transfer by gift. There is also talk that he would lower the federal estate tax exemption from its current $11.58 million per person back to the previous $3.5 million level. 

[1] For the sake of keeping our descriptions simple, this paper refers to gifting or transferring an asset to children, but please note that the strategies discussed generally enable such transfers to a variety of people and entities, or to trusts for their benefit.


Fieldpoint Private does not provide tax or legal advice.  Please consult your personal tax or legal advisor regarding your particular circumstances. This material is not an offer or solicitation to purchase or sell any security or to employ a specific investment strategy. No part of this material may be reproduced or retransmitted in any manner without prior written permission of Fieldpoint Private. Fieldpoint Pri­vate does not represent, warrant or guarantee that this material is accurate, complete or suitable for any purpose and it should not be used as the sole basis for investment decisions. The information used in preparing these materials may have been obtained from public sources. Fieldpoint Private assumes no responsibility for independent verification of such information and has relied on such information being complete and accurate in all material respects. Fieldpoint Private assumes no obligation to update or otherwise revise these materials. This material does not purport to contain all of the information that a prospective investor may wish to consider and is not to be relied upon or used in substitution for the exercise of independent judgment and careful consideration of the investor’s specific objectives, needs and circumstances. Fieldpoint Private does not provide legal or tax advice, and nothing herein should be construed as such. Wealth manage­ment, registered investment advisory, and securities brokerage services offered by Fieldpoint Private Securities, LLC. Such services and/or any non-deposit investment products which ultimately may be acquired as a result of Fieldpoint Private’s investment advisory services:
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