Over the last decade, historically low interest rates shaped many estate planning strategies. But times have changed. As interest rates rise, certain techniques that once delivered significant tax benefits may lose some appeal—while others become more effective.
If you’re a business owner or high-net-worth individual considering succession and estate planning, it’s essential to understand how today’s rate environment can impact your plan.
Why Interest Rates Matter in Estate Planning
Many popular wealth transfer strategies use Internal Revenue Code Section 7520 rates (“Section 7520 rates”) or the Applicable Federal Rates (“AFRs”) published monthly by the IRS. These rates are used to calculate:
- The present value of annuities or retained interests
- The value of charitable gifts
- The value of loans to family members
When rates rise, the IRS assumes that assets grow faster. Depending on the strategy, this can either increase or decrease the taxable value of a transfer.
For example:
GRATs (Grantor Retained Annuity Trusts) and intra-family loans typically work better in low-interest rate environments because the hurdle rate is lower.
Charitable Remainder Trusts (CRTs), Qualified Personal Residence Trusts (QPRTs), and Installment Sales to Intentionally Defective Grantor Trusts (IDGTs) can be more effective in higher-rate environments.
Let’s take a closer look.
Strategies That Are More Powerful When Rates Are High
- Qualified Personal Residence Trusts (QPRTs)
A QPRT allows you to transfer a personal residence or vacation home to heirs at a discounted gift tax value while retaining the right to live in the home for a set term of years.
Why do higher interest rates help?
When you create a QPRT, the value of the retained right to live in the house (the “retained interest”) is calculated using the Section 7520 rate. A higher 7520 rate increases the value of the retained interest, reducing the taxable value of the gift.
Example:
In a low-rate environment, a $2 million home transferred into a QPRT might result in a taxable gift of $1.2 million. With higher rates, the retained interest is valued more highly, and the taxable gift could be as low as $1 million or less—saving gift and estate taxes.
- Charitable Remainder Trusts (CRTs)
A CRT allows you to donate assets to a trust, receive income for life or a term of years, and pass the remainder to charity. You get an immediate income tax deduction based on the value of the charitable remainder.
Why do higher interest rates help?
When rates are higher, the assumed growth rate for the remainder interest increases, making the charitable deduction larger. This makes CRTs more appealing as an income and estate tax strategy in higher-rate environments.
- Installment Sales to IDGTs
This technique involves selling appreciating assets (like a business or real estate) to an intentionally defective grantor trust in exchange for a promissory note. The transaction freezes the value of the asset in your estate while allowing future growth to pass to beneficiaries free of estate tax.
Why can higher rates be beneficial?
The interest rate you must charge on the promissory note is set by the Applicable Federal Rate (AFR). In higher-rate environments, the note requires larger interest payments to you, which can help support your cash flow during retirement or liquidity needs. Plus, the higher payments may further reduce the value of the estate over time.
- Charitable Lead Annuity Trusts (CLATs) – Non-Grantor
A CLAT pays an annual income to a charity for a term of years, then distributes the remainder to heirs. In higher-rate environments, the present value of the charitable lead payments is higher, reducing the taxable value of the gift to your beneficiaries.
This makes CLATs especially attractive if you have philanthropic goals and want to pass wealth to the next generation tax-efficiently.
Additional Considerations for Business Succession
Buy-Sell Agreements and Redemption Funding:
If you have a buy-sell agreement funded by loans or deferred payments, higher rates can impact the cost of financing a redemption. It may be worth revisiting your buy-sell provisions to ensure funding sources are still feasible.
Valuation Discounts:
Higher interest rates often increase capitalization rates, which can reduce the appraised value of operating businesses or real estate. In some cases, this may create opportunities to make gifts or sales at a lower valuation.
The Bottom Line
Rising interest rates don’t mean you should put off your succession or estate planning. On the contrary, certain strategies become more advantageous in this environment.
If you’re considering transferring your business or wealth to the next generation or supporting charity, now may be an opportune time to act.
Estate Planning services are provided working in conjunction with your Estate Planning Attorney, Tax Attorney and/or CPA. Consult them for specific advice on legal and tax matters.
Neither MML Investors Services nor any of its subsidiaries, employees or agents are authorized to give legal or tax advice. Consult your own personal attorney, legal or tax counsel for advice on specific legal and tax matters.