June 30, 2020
Haverford Trust Financial Planning Team

COVID-19 has shocked our personal lives and the economy, and it has resulted in important actions including the passing of the CARES Act and the on-going commitment of the Federal Reserve to keep interest rates at historically low levels. This combination of factors presents an optimal opportunity for an estate plan review. It is important to note that many strategies discussed here are time sensitive.

The interest rates on family loans, mortgages, and loans to trusts have been impacted by the Federal Reserve’s recent actions, creating rare opportunities for significant tax savings on transfers. The actual interest rates change monthly based on a handful of factors. The applicable rates for July 2020 are below, as well as prior rates from January 2020 and July of 2019 to illustrate the quick change that has occurred.

Family Loans
Sometimes you may want to help out your child or beneficiary, but gifting money outright isn’t the best strategy. This is when family loans could be a viable option to consider. Family loans are drawn between two individuals without going through a bank. For the loan not to be considered a gift, the loan must have an interest rate (at or above the current Applicable Federal Rate or “AFR”) and a repayment schedule. See the chart above for the July 2020 AFRs by duration or term of the loan. While traditional bank loans are at all-time lows, you might take advantage of these even lower rates for a family loan. With little to no closing costs and this dramatic drop in the AFR, you should also review current family loans and consider refinancing.

Refinance
With interest rates at all-time lows, it is important to review your current liabilities. We have seen rate quotes in the high 2% and lower 3% range on a consistent basis for most mortgages recently. These rates vary based on the size of your loan and other personal factors. When determining if refinancing makes sense, consider your current mortgage interest rate, closing costs, and the duration of your current and future mortgage.

Grantor Retained Annuity Trusts (GRATs)
A GRAT is a type of irrevocable trust where the grantor makes a gift to a family member while agreeing to receive a series of annuity payments over a certain period, which is determined by the size of the gift. The best way to think of GRATs is that their effectiveness has an inverse relationship with interest rates–as rates go down the effectiveness goes up. As the chart above shows, the July 2020 AFR is 0.60% for annuities, making it attractive to create GRATs now. After the annuity period is over, the assets will transfer to the designated family member or members tax-free, less the hurdle rate2.

Charitable Donations & Trusts
This tax season (2020) there is an added benefit to donating cash to charity. Charitable cash donations will be 100% deductible up to your adjusted gross income if they are made to public charities. This means you can use your cash donations in 2020 to help offset a larger portion of your salary, bonuses, dividends, interest, or capital gains from the sale of a business or investments. In addition to cash donations, Charitable Lead Annuity Trusts (CLATs) can be especially effective in low interest rate environments. CLATs are similar to GRATs in the way that they generate annuity payments, but in this case, those payments are received by the charity. At the end of the charitable annuity period, your family member will still benefit from any asset appreciation over the AFR hurdle rate.

Gifting Strategies
Another way to make an advantage of the economic slowdown is to consider gifting assets now while values may be reduced. If you were already planning to gift some assets in the future, the lower values now could lessen the effect on your estate while still meeting the same end goal and allowing your heirs to benefit from the potential for rising values in the future.

Exemption Amounts
The Federal Estate Tax exemption amount will continue to stay at today’s elevated rate until 2026, when it is set to drop back to the lower pre-2017 tax reform amount. For business owners and ultra-high net worth individuals, it may make sense to consider using up as much of your exemption as possible. You will be able to gift your assets now, using the much higher $11.58 million per person limit, leaving less in your estate if the exemption reverts in 2026 or were otherwise reduced through future tax legislation.

Roth Conversions
When the SECURE Act passed in 2019, conversions from traditional IRAs to Roth IRAs became an efficient estate planning strategy. We discussed this strategy with many clients back in 2019, and it has become even more effective with the most recent market downturn. You may consider a one-time conversion or a reoccurring conversion, and converting may help combat the death of the Stretch IRA. When you convert a traditional IRA to a Roth IRA, you pay tax at the current rate.  When the money is withdrawn later by your heirs, the distributions are tax-free, unlike distributions from an inherited IRA.  The caveat to this strategy is that one can never guarantee future tax laws and how they will treat inherited Roth IRAs. If the tax treatment continues as it is today, a conversion can benefit the anticipated future growth of currently depreciated assets. There have been some articles stating that the depressed account values will cause you to pay less tax, but keep in mind that this is only true if you plan to convert your entire account.

Another reason to consider a Roth conversion in 2020 is because the CARES Act allows those with an RMD to skip this year’s distribution. If you have an RMD and waived your 2020 distribution, consider converting a similar amount into a Roth IRA. You should discuss this strategy with your Portfolio Manager and accountant as it is a balancing act between your investment strategy and current/future tax situation.

Please reach out to your portfolio manager if you have any further questions regarding these strategies. Our team of planners and trust officers would welcome a conversation about how to take advantage of these strategies.

 

1 Source: https://apps.irs.gov/app/picklist/list/federalRates.html
2 The hurdle rate is equal to the applicable federal rate tied to the length of the loan to the trust.


The information provided herein is not intended to be, and should not be construed as, legal or tax advice or a legal opinion. Haverford does not provide legal or tax advice. You should contact your legal or tax advisor regarding your specific tax situation prior to taking any action based upon this information.

Investments in securities are not FDIC insured · Not bank guaranteed · May lose value.