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  • Barry Boscoe

Historic Low AFRs Provide Wealth Transfer Possibilities

With the low current interest rate environment and the published IRS applicable federal rates (AFR), we are witnessing phenomenally low rates such as 1.9% for long term, nine years or more. The advantage of this low AFR is the utilization of certain techniques that leverage the low interest rate when compared to the same techniques with higher interest rates.

The August long-term AFR is by far the lowest we have seen published since at least 2000. This low interest rate provides an opportunity that has probably not been seen in quite some time.

Some of the techniques that avail themselves to low interest rates would be private intra-family loans, selling assets to family members or grantor trusts.

By way of example, your client has earmarked $5M for wealth transfer purposes to his heirs. In order to minimize the gift tax consequences, one solution proposed would be to make a $500,000 gift to a grantor irrevocable trust. Once the gift has been made, you can then lend the remaining $4.5M to the same trust using a private loan. The loan could be created as a 20 year interest only term note having a balloon payment at the end of the 20 years. The trustee will then invest the loan and gift, in order to receive a return. The AFR for this loan would be 1.9% providing significantly greater wealth to the next generation versus had this been done in July when the AFR was 2.18%.

To illustrate how significant the reduction in the August AFR rate is, versus had this been done in July, assume that after interest has been repaid the remaining balance, generating a 5% return, will grow to $10,022,718 using the July AFR rate at the end of 20 years. At that point, the trust will repay the $4.5M loan providing a profit of $5,522,718 to the trust beneficiaries. Utilizing this same structure, but using the August long-term AFR, the trust would grow to $10,439 by year 20. After loan repayment the increase in value to the beneficiaries is a whopping $416,631 of wealth transfer due to simply utilizing a lower interest rate.

Some of the strategies benefiting from these low rates include the following:

Private loans to trusts or family members. Selling assets to either trusts or family members in exchange for a promissory note. Utilizing a GRAT – Grantor Retained Annuity Trust, which in turn utilizes a rate to calculate the required annuity payment back to the grantor. This rate is 1.4% for August. The lower the rate, the larger the wealth transfer opportunity. Charitable Lead Annuity Trusts (CLAT). These are similar to GRATs mentioned above, except that the annuity payments, instead of being made to the grantor, are made to a charity. The rate for this is also 1.4% in August. As you can see, this enables a charitably inclined individual to provide significant wealth transfer to their heirs.

In order to take advantage of these strategies, it is important to work with your trusted advisors.

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