Estate Planning Strategies In An Interest Rate Cut Environment

With the potential January 1, 2026, sunset of the Tax Cuts and Jobs Act of 2017 (TCJA) and the resulting reduction of the federal estate and gift tax exemption to an estimated $7.2 million, advisors should re-evaluate the use of Grantor Retained Annuity Trusts (GRATs), Charitable Lead Trusts (CLTs), intra-family loans, and sales to Intentionally Defective Grantor Trusts (IDGTs) for high-net-worth clients.

The Role of Grantor Retained Annuity Trusts A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust that allows a grantor to contribute assets in return for a fixed annual payment over a set term. The present value of this retained right is based on the IRS 7520 Rate, a benchmark derived from 120% of the mid-term AFR rate, which can significantly impact the trust's efficiency. GRATs are particularly advantageous when assets are expected to appreciate beyond the 7520 Rate, as this increases the residual value passed to beneficiaries at little to no gift tax cost. Lower 7520 Rates mean a lower "hurdle rate," which can enhance the trust’s effectiveness, especially with zeroed-out GRATs or “graduated GRATs,” where the annuity amount can increase by up to 20% annually.

For example, in October 2024, if a grantor places $5 million into a two-year zeroed-out GRAT with a 4.4% 7520 Rate, they would receive around $2.43 million in the first year and $2.91 million in the second. If the assets appreciate at 10% annually, about $465,000 could pass to beneficiaries tax-free. Had this GRAT been established in October 2023, when the 7520 Rate was 5.4%, beneficiaries would have received only around $382,000—a difference of nearly $83,000.

Additionally, clients may benefit from executing “rolling GRATs” to hedge against mortality risk and fluctuating 7520 Rates. Importantly, distributions can go outright to beneficiaries or to a trust but generally should avoid "skip persons" due to generation-skipping transfer tax (GSTT) exemption rules.

Charitable Lead Trusts: Tax-Advantaged Giving A Charitable Lead Trust (CLT) distributes a fixed amount annually to charity, with any remainder passing to non-charitable beneficiaries at the end of the term. A lower 7520 Rate enhances the charitable deduction, making CLTs particularly attractive in a low-rate environment. For example, in October 2024, a $2 million contribution to a 10-year CLAT with a 4.4% 7520 Rate could yield a $1.83 million charitable deduction, with a remainder interest of $170,000. By contrast, if established in October 2023 with a 5.0% rate, the deduction would decrease to $1.776 million, reducing the tax benefits of any remainder interest for beneficiaries.

Leveraging Intra-Family Loans for Wealth Transfer Intra-family loans allow clients to lend assets within the family without using gift tax exemptions. These loans offer favorable terms with AFR-based minimum interest rates, which are generally lower than commercial rates. Advisors may recommend intra-family loans with interest-only payments or balloon payment structures, secured by asset pledges as collateral. As AFR rates drop, clients may benefit from locking in lower rates on long-term loans.

For example, a two-year $1 million loan in October 2024 at a 4.21% short-term AFR, assuming a 7% annual growth rate, could leave approximately $60,000 in the borrower’s assets after interest and principal payments. If the same loan had been made in October 2023, when the AFR was 5.22%, only about $37,000 would remain. Advisors should review terms of existing intra-family loans for potential refinancing if prepayment options are available.

The Appeal of Sales to Intentionally Defective Grantor Trusts

Sales to IDGTs are especially useful when interest rates decline. An IDGT is treated as a completed gift for estate and gift tax purposes but is "defective" for income tax purposes. For assets expected to appreciate, this allows the transfer of future growth outside the grantor's estate, while income tax obligations remain with the grantor. To establish an IDGT, a grantor may sell assets to the trust, funded with seed capital equal to roughly 10% of the asset’s value, in exchange for a promissory note.

For instance, a grantor contributing $1 million to an IDGT in October 2024, followed by a $10 million asset sale to the trust at a 3.7% mid-term AFR, could retain significant value for beneficiaries as assets appreciate. If the business interests sold to the IDGT grow to $30 million, they could escape the estate tax while the grantor covers the income tax. By comparison, in October 2023, with a mid-term AFR of 4.43%, the IDGT might yield about $700,000 less due to higher interest costs.

Strategic Review of Estate Planning Approaches With rates dropping, the possible sunset of the TCJA, and the return to a reduced federal estate and gift tax exemption, advisors should carefully review GRATs, CLTs, intra-family loans, and IDGT sales for high-net-worth clients. Implementing these strategies allows clients to transfer assets efficiently while taking advantage of the low-rate environment, especially for those who have maximized their gift tax exemption.

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