Wealth Transfer Guide: A Step By Step Overview On Transferring Wealth in a Low Interest Rate Environment

By Andy McNamara on August 25, 2021

The Benefit of a Wealth Transfer

Parents want the best for their children, and after building your wealth you may want to help your children or other future generations during your lifetime. A great benefit to transferring your assets during your lifetime is that you get to see how the transferred family wealth benefits the future generations in real time which can be invaluable and very fulfilling.

When it comes to generational wealth transfer, it can differ in how much wealth (if any) an individual will want to transfer to their children during their lifetime as there are many factors that go into the decision of how much, how often, and on what terms. When beginning the process, it is always a good idea to work with your financial advisor on wealth transfer best practices as part of your overall wealth management plan. If you decide you want to help future generations build their wealth or help your children with their first home purchase, here are some techniques to transfer your wealth, including strategies that are more impactful in this low interest rate environment.

How To Transfer Wealth in a Low Interest Rate Environment

Wealth Transfer Strategy #1: Gifting

One of the simplest ways to transfer your wealth to your children or grandchildren is to help them build their wealth by gifting money to them. When it comes to gifting, you will need to be mindful of potential wealth transfer taxation. It is important to note there is an annual exclusion amount, as well as a lifetime exemption amount, in which you can gift.  What that means is that you can gift up to $15,000 to another individual in a given year and it will not count against your lifetime exemption, which for an individual is currently set at $11.7 million. A married couple can gift up to $30,000 to one individual in a given year and still fall under the annual exclusion amount and can gift up to $23.4 million during their lifetimes (based on current lifetime exemption amounts).

What happens if I gift more than $15,000 in a given year as an individual?  That gift will count against your lifetime exclusion, however unless you have surpassed the $11.7 million threshold for an individual, you will not owe gift taxes in the current year, rather you will have to file Form 709 when you complete your taxes so the IRS can keep track of your lifetime gifts.

Let’s look at this in an example. If you gift $700,000 to your child to buy real estate, your total lifetime exclusion amount will now be reduced to $11 million.  You would then be able to gift up to $11 million more throughout the rest of your life, and still owe no gift taxes.  Another workaround is that you can pay for education and medical expenses without it counting against your annual or lifetime exclusion amounts, with the caveat that the payments must go directly to the school or medical provider.  If the payments do not go directly to the school or medical provider, the gift will count against your annual exclusion and potentially your lifetime exclusion.

One last thing to keep in mind when financial planning for future education expenses is that you are allowed to bunch 5 years of contributions into a 529 education savings account in a single year.  An individual can contribute $75,000 and a married couple can contribute $150,000 to a 529 account in a single year.  You will have to wait 5 years in order to contribute again, but the benefit of compound interest and the time value of money can make this gifting strategy very efficient.

What Else Can You Gift To A Beneficiary?

You can also gift other assets such as stocks, bonds, mutual funds, real estate, and other items of value.  One thing to keep in mind if gifting more complex assets than stocks, bonds, or cash, is that a professional appraisal might be needed in order to determine the fair market value of the gift.  Also, if you are planning on giving large gifts to future generations, it is best to contemplate them now as the lifetime exclusion amount is set to revert back to the levels before the Tax Cuts and Job Act was enacted into law, which will essentially cut the current lifetime exclusion in half after 2025.

Wealth Transfer Strategy #2: Family Loans

Another great way to help future generations build wealth is through a Family Loan.

Providing a loan to your children or grandchildren could be a good option if you are considering intergenerational wealth transfer. You can loan up to $10,000 with no interest, however any amount over that will have to use the current Applicable Federal Rate for the corresponding length of the loan.  In the current interest rate environment, the current Long Term Applicable Federal Rate for August 2021 is 1.89%, which means you can most likely lend money at a much lower rate than they would be able to find at a traditional lending institution. You can lend them money to start a business, buy a car, or simply loan them the money and they could invest the proceeds to arbitrage the long-term return of the stock market versus the low interest rate loan if they have enough cash flow to manage the payments.

If your children have student loan debt, consider lending enough to allow them to pay off the loan with the new lower interest rate and therefore lower monthly payment; it may open-up their ability to save more and allow you to start the conversation of the importance of saving and investment planning. Something to keep in mind is that this will be considered a loan for IRS purposes, so there should be appropriate paperwork signed by all parties for proof of the legitimacy of the loan in preparation if the IRS does come knocking.

Wealth Transfer Strategy #3: Family Mortgage

A more specialized type of family loan is a Family Mortgage.

The basic principles of the family loan are retained, with the added bonus of the borrower (your child) being able to deduct the mortgage interest for tax purposes assuming the loan follows IRS guidelines and they itemize deductions. The lender (you) will have to declare the interest income on your tax return as well. The benefit as a buyer (your child), being able to position themself to the seller as an all-cash offer coupled with the ability to do a quick close on the home sale may just seal the deal in this very competitive housing market.  If your child is looking to purchase their first home, or move into a bigger home, this may be an effective strategy to use your wealth to help them build their wealth.

More Advanced Wealth Transfer Techniques

The three easiest ways to help future generations build wealth is by gifting, a family loan, or a family mortgage. All three are beneficial in this low interest rate environment, however a family loan and family mortgage are particularly attractive given the low interest rates at which you can loan the money to your heirs.

A couple more complex techniques that will help you reduce your taxable estate, and help future generations build wealth will involve the coordination of your financial advisor, tax professional, and estate attorney. With that said, if these techniques are structured properly, they can be a very efficient way to transfer your wealth and help future generations build their wealth. When jotting down questions to ask your financial professionals be sure to inquire about two types of trusts—the GRAT and CLAT.

Wealth Transfer Strategy #4: Grantor Retained Annuity Trust

The first more complex technique is called a Grantor Retained Annuity Trust (GRAT). It can be used as an estate planning technique that allows you to indirectly gift assets to your children, while paying very little (if any) gift tax on the wealth transfer. How does the GRAT work? You (the grantor) create an irrevocable trust for a certain period of time (typically 2 years) and transfer assets into the trust, while naming your children as the remainder beneficiaries of the trust. Once the assets are in the trust, you are required to receive a stream of income (hence the word annuity in the name of the technique) based on the 7520 Rate, which is 120% of the mid-term AFR rate, and in August 2021 is only 1.2%. If the assets appreciate at a rate that is higher than the 7520 Rate, then all the assets appreciation above the 7520 Rate passes to the designated remainder beneficiaries at the end of the trust term with little or no gift tax implications.

What happens if the assets don’t appreciate above the 7520 Rate? The grantor still receives the income stream from the depressed assets and gets all of their principal back at the end of the trust term.  The downside of a GRAT is the cost of setting up the trust, however the upside to your estate plan of getting appreciating assets out of your estate and into the hands of the next generation can potentially save a lot in estate taxes in addition to helping the next generation build their wealth.

Wealth Transfer Strategy #5: Charitable Lead Annuity Trust

For those that are charitably inclined, another potential wealth transfer technique that is especially beneficial in this low interest rate environment is a Charitable Lead Annuity Trust (CLAT). A Charitable Lead Annuity Trust is set up so a donor transfers money into an irrevocable trust, and the trust pays a charitable beneficiary a stream of income for the life of the trust, and at the end, whatever is left over in the trust passes to the non-charitable trust beneficiaries. The reason it is beneficial in this low interest rate environment is because a Charitable Lead Annuity Trust also uses the 7520 Rate to determine the interest rate for the annuity payments to the charity and any asset appreciation within the trust that is greater than the 7520 rate, passes to the non-charitable beneficiary gift tax free. Depending on how you set up the Charitable Lead Annuity Trust, as a grantor or non-grantor trust, will create different benefits. If you set up the trust as a grantor trust, you can benefit from an immediate charitable tax deduction, with the caveat that the grantor would then have to report any income in the trust on their own tax return.

Both the Grantor Retained Annuity Trust and the Charitable Lead Annuity Trust wealth transfer techniques do have the ability to transfer family wealth effectively if structured properly, but they can be very complex as well based on your individual goals pertaining to family wealth preservation. This low interest rate environment that we are currently in gives you the ability to use one of these techniques to get appreciating assets out of your estate, and into the hands of the next generation with little to no gift tax implications if structured properly.

Bottom Line

If you are considering transferring wealth using any of these techniques, especially the GRAT and the CLAT, please consult your Dowling & Yahnke Certified Financial Planner® in coordination with your tax professional and estate planning attorney. If you are looking for a dedicated San Diego financial advisor, be sure to contact us today to learn more!


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