Interest rates are at historical lows, including the Applicable Federal Rates (AFR) used in many estate- and business-planning techniques. For June 2020, the AFR are as follows:
Except for the short-term AFR, these rates are the lowest they have ever been. And while we might expect them to remain low, at least for the time being, now is the time to consider the benefits that these low rates can offer clients looking to purchase life insurance as part of certain estate- or business-planning solutions.
Let’s explore the various options before interest rates go up.
Private financing refers to a loan arrangement between a grantor and his/her irrevocable life insurance trust (ILIT), in which the grantor makes a loan to the trust in return for a promissory note — with interest charged at the applicable interest rate designated for the month in which the loan is first made.
We have seen recent success using private financing loans with affluent clients in particular, when they are hesitant to make large gifts. Rather than make an irrevocable gift today, these clients use private financing to create a “wait-and-see” approach that allows them purchase life insurance today, but easily make a gift in the future should they decide to. Click here to read about a recent case utilizing the wait-and-see strategy or listen to this webinar to learn more.
A sale to a defective grantor trust is very similar to private financing, but is used when the client wants to transfer illiquid assets — such as real estate or closely held business stock — into a trust in return for a promissory note charging interest. This strategy can be especially advantageous during times when there are depressed market values. For more information on this strategy, click here.
A GRAT is a popular wealth-transfer technique that’s often used in conjunction with other planning techniques as an “exit strategy.” For example, a client could initiate the purchase of life insurance inside an ILIT using a private split-dollar arrangement while simultaneously funding a GRAT whose remainder interest will flow into the ILIT at the end of the GRAT term, thereby giving the ILIT the funds needed to repay the grantor and terminate the split-dollar arrangement. GRATs are often used with other interest-rate oriented techniques, such as private financing and premium financing.
Businesses and employers can also take advantage of low AFR rates for certain planning needs. For example, business owners may use split-dollar loans between the business and the owners themselves to help pay for a life insurance policy for business-succession purposes. Alternatively, a business could use split-dollar loans to provide a tax-efficient executive benefit to help retain and reward a key employee.
Click here to learn more about split-dollar loans and their application in the business space.
Financing options at a glance
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Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws (including the generation-skipping tax). Failure to do so could result in adverse tax treatment of trust proceeds.
This material does not constitute tax, legal, investment or accounting advice and is not intended for use by a taxpayer for the purposes of avoiding any IRS penalty. Comments on taxation are based on tax law current as of the time we produced the material.
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Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws (including the generation-skipping tax). Failure to do so could result in adverse tax treatment of trust proceeds.
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