Wealth preservation strategies in a rising rate environment

Personal legacy planningWealth preservation strategies in a high interest rate environment

Key things to know

  • Wealth preservation requires strategic thinking to help minimize the impact of income and estate taxes.

  • Today’s high interest rate environment could be a factor in how you protect your estate.

  • Consider market-driven estate-reduction and annual tax strategies to reduce your tax liability and protect your wealth for the future.

Finding ways to limit tax liability has always been at the center of wealth preservation strategies. As you consider your options, it’s important to incorporate the current economic and tax environment into your decision-making process.

A high interest rate environment and attractive valuations could be critical factors in assessing which estate planning and tax strategies are most applicable to your circumstances.

Estate and gift tax strategies

Assets included in your estate at death are subject to federal estate tax at a rate of 40%. Assets gifted during your lifetime are taxed at the same rate. The unified federal estate and gift tax exemption shields a portion of your assets or gifts from this tax (using the exemption during your lifetime to make gifts reduces the exemption available at your death).

In 2024, the exemption is $13.61 million per individual and $27.22 million for married couples filing jointly. Keep in mind that the current law expires at the end of 2025 and, unless changes are made, the exemption amount will be roll back to around $7 million, adjusted for inflation.

Consider how the following strategies may help you optimize the use of these exemption amounts in the current economic environment.

Qualified Personal Residence Trust (QPRT)

Real estate may represent a sizable position in your estate. A primary home, additional homes or other personal use real estate could be placed into a QPRT. As the grantor, you retain the right to use the property over the term of the trust. At the end of that term, ownership then passes to the trust beneficiaries, typically your descendants.

A high interest rate environment and attractive valuations could be critical factors in assessing which estate planning and tax strategies are most applicable to your circumstances.

QPRTs are an example of a “split interest trust” where the trust is split between the present interest—your retained right to use the property—and the remainder interest—the beneficiary’s right to receive the property once the term of the trust ends. For gift tax purposes, a gift to a QPRT is reduced by the value of the present interest.

QPRTs can be good planning options in a high interest rate environment. The higher the interest rate, the greater the value of your present interest and the lower the value of your taxable gift. That limits the gift tax exemption that must be allocated to the transfer by you as the grantor of the trust, preserving more of your estate tax exemption.

Charitable Remainder Trust (CRT)

If you intend to pursue charitable goals, a CRT can provide added tax benefits, particularly when interest rates are high. As the grantor, you place assets in a trust and name a qualified 501(c)(3) organization as the remainder beneficiary of the trust. You retain the right to receive a stream of payments over the term of the trust, either in the form an annuity or unitrust. At the end of the term, the remaining balance of the gift is directed to the charity.

A gift to a CRT is valued based on interest rates provided by the IRS. When interest rates are elevated, the value of the annuity or unitrust payment is depressed, which increases the remainder value. That results in a larger gift to the charity, removing your initial gift plus the appreciated principal value from your estate.

This strategy can also be used to manage a concentrated and highly appreciated investment position in a single security or entity. The asset can be placed in the trust, then fully or partially liquidated to build a more diversified portfolio. Resulting capital gains are held within the trust and become taxable only as they are paid to you in increments over the term of the trust, effectively deferring and reducing your tax liability.

Grantor Retained Annuity Trust (GRAT)

If you have assets that are positioned to generate significant future appreciation, consider placing them in a GRAT. You receive a stream of annuity payments from the trust and at the end of the trust term, the remaining value of the trust is directed to a designated beneficiary.

Interest rates provided by the IRS create a “hurdle” rate, or the rate at which the GRAT assets must appreciate so that the value of the GRAT at the end of the term exceeds the required annuity payments. The annuity amount is determined based on the initial value of assets gifted to the trust, so assets with a currently low value that are expected to appreciate can be good targets for gifts to GRATs.

GRATs are a tremendous asset-transfer vehicle because all appreciation in excess of the annuity payments can be removed from your estate without requiring the allocation of any gift tax exemption to the transfer.

Sale to a grantor trust

Another estate-reduction approach is to establish a grantor trust, then sell an asset to the trust. The asset could be an active business with growth potential or a security that is currently depressed in value but is well-positioned for a rebound. While the current value of the asset remains in your estate, moving the asset to the trust allows any growth in value beyond the sale price to be shifted outside of the estate.

The trust can pay the sales price using a promissory note. In this case, instead of receiving the full purchase price up front, you receive a stream of income payments while the promissory note is repaid by the trust. Payments could be interest-only with a balloon payment of the principal returned at the end of the term. Or payments can include principal and interest, amortized over the term of the promissory note.

An additional benefit of a grantor trust is that income taxes are paid by the grantor. This allows assets inside the trust to compound without being depleted by tax liabilities. If the trust allows, you can also swap assets from inside the trust to outside the trust and vice versa.

Assets with a low cost basis (and therefore the greatest tax liability when sold) can remain in your estate, and the asset’s cost basis will be “stepped-up” to its fair market value on the day of your death, reducing the tax burden for your beneficiaries.

Managing income tax liabilities

In addition to estate-reduction strategies to help manage large assets or estates in the long-term, there are several annual tax-saving strategies to consider, including:

  • Tax-loss harvesting. If you hold investment positions that have lost value, there is a tax-beneficial strategy to selling those assets and claiming the tax loss, which can offset other investment gains you realize. This will reduce your capital gains tax burden.
  • Strategic charitable gifting. As you provide support to your favored nonprofits, consider the benefits of donating appreciated securities rather than gifting cash. You still claim a tax deduction for the gift without having to realize a capital gain by selling the security first. If your preferred charity can’t accept securities, you can gift the securities to a donor-advised fund and direct the gift to the charity from that source, still avoiding the capital gains tax.
  • Qualified Charitable Deductions (QCDs) from IRAs. This is an efficient way to limit the tax consequences of required minimum distributions. Up to $105,000 in 2024 (adjusted annually for inflation) can be distributed directly from your combined IRAs to qualified charities. That reduces the amount of taxable distributions you must claim in a given year.

Finding the right strategies for your circumstances

These are just some of the ways you can potentially reduce your tax burden today, preserving more of your wealth for the future. The best strategy is one that’s designed to meet your specific circumstances and goals.

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Strategies to maximize your charitable giving

Donor-advised funds, qualified charitable distributions and gifts of appreciated stocks offer prime opportunities to enhance your giving and potentially take advantage of greater tax savings.

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