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Estate Planning Considerations in a Rising Interest Rate Environment

October 2022 / 3 minute read
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While rising interest rates impact borrowing costs, stocks, bonds, and other financial instruments, they also can affect estate planning strategies. Different planning strategies work well in a low interest rate environment while others are more suited when interest rates are higher.

For more than a decade, interest rates have been historically low. And even with the recent rise, rates remain relatively low. But with the possibility that they will continue to move up, it is important to consider the estate planning opportunities that work better in a higher interest rate environment.

The Federal Reserve, concerned about rising inflation, has raised its benchmark interest rate 3% during the first nine months of 2022. That puts the current fed funds rate in the 3%-3.25% range, still quite low by historical standards. But given the Russia-Ukraine war is fueling inflation, which began in the aftermath of the COVID-19 pandemic, the Fed has indicated more hikes are possible over the next year or so.

“Now is a good time to review your existing estate plan to come up with the best approach that takes into consideration the current interest rate environment and what could be ahead,” said Kelly Oliven, a William Blair senior wealth planner. “As always, it is important to weigh the potential benefits and risks of different strategies before changing any plans.”

Some estate planning tools to consider in a rising rate environment are:

Qualified Personal Residence Trust. A QPRT is an estate planning technique that allows a grantor to give his or her personal residence to a trust for the benefit of one’s family at a reduced gift tax cost while retaining the right to live in the home for a term of years. It essentially freezes the value of the taxpayer’s residence at the time the trust is created, resulting in a significant estate tax savings. The federal interest rate under the Internal Revenue Code section 7520 is a main factor impacting the value of the gift residence. So as the 7520 rate increases, the value of the taxable gift decreases, making the QPRT a more attractive strategy with higher interest rates.

Charitable Remainder Annuity Trust. With this type of irrevocable trust, the grantor (or selected beneficiaries) receives an annual annuity from the trust for a term of years. The assets remaining in the trust at the end of the term are distributed to the grantor’s chosen charitable beneficiaries. The year the trust is created, the grantor is entitled to a charitable income tax deduction which is calculated using the 7520 rate. Higher interest rates increase the imputed value of the remainder interest passing to the charity, leading to a larger charitable deduction for the grantor. Transferred assets are also exempt from capital gains tax on the sale of those assets.

Swapping Out Assets in an Irrevocable Trust. Some irrevocable trusts include a power to substitute assets. Considering this year’s market decline it may be advantageous to swap out certain low-basis assets (after a thorough review) in the irrevocable trust with assets currently in your taxable estate. Those low-basis assets will then be eligible to receive a step up in basis for income tax purposes at death.

Gifts. Given the decline in financial markets this year, it is an opportune time to make gifts of low-value stocks with high appreciating value. An annual tax-free gift of up to $16,000 does not count against your lifetime gift tax exclusion. Another consideration is making taxable gifts of low-valued assets above the annual exclusion limit. Even though they count against one’s lifetime exclusion, any future appreciation would grow outside of your taxable estate.

Roth Conversions. Since the income tax on converting a traditional IRA into a Roth is calculated on the value of the securities in the account on the date the conversion is made, you may consider making conversions when the market is down.

More Information

Your William Blair advisor can help you evaluate your current estate plan and whether it’s time to make any adjustments. For more information, contact your William Blair advisor or email PWM.

This information has been prepared solely for informational purposes and is not intended to provide or should not be relied upon for accounting, legal, tax, or investment advice. We recommend consulting your attorney, tax advisor, investment advisor, or other professional advisor about your particular situation.