When discussing higher interest rates, it’s not so much a question of if as it is one of when. The Fed may have balked at raising rates in September, but the option remains in consideration for this year or early 2016. And while it’s no secret higher rates can arrive with a host of investment return and borrowing implications — some good, some bad — not many people realize they can also affect estate planning.
The golden age of estate planning
Not only do we currently have a record high federal estate tax exemption — $5,450,000 for 2016 — but tax rates have also dropped from a high of 55% to the current 40%. At the same time, the economic environment — characterized by low interest rates and positive stock market returns — remains favorable toward estate planning.
Many estate planning strategies have benefited from low interest rates, but it’s important to understand that other factors, such as the length of a trust, also can have an impact and that the expected rising-rate environment doesn’t mean you don’t have options when planning your estate. (For a breakdown of how interest rates affect estate planning, see the sidebar “Interest Rates Impact Estate Planning.”)
Different rates, different uses
Many estate planning strategies rely on the IRS’s section 7520 interest rate, calculated by multiplying the average market yield — known as the applicable federal rate, or AFR — of certain U.S. obligations by 120%. So when interest rates rise, so do the AFR and the 7520 rate.
Keeping things in perspective
The reality is that interest rates would need to rise significantly before many of the current estate planning strategies fall out of favor, and the current consensus calls for only small, gradual increases. Since that’s the case, we believe a rise in rates may make the economics of select strategies only slightly less attractive. And some strategies are actually better with higher rates. We are far from the tipping point, which would call for a change in planning techniques. At most, a rising-rate environment may simply require you to determine when to implement a particular strategy, rather than suggest that you abandon the strategy altogether.
Any information presented about tax considerations affecting client financial transactions or arrangements is not intended as tax advice and should not be relied upon for the purpose of avoiding any tax penalties. Neither U.S. Trust and its representatives nor its advisors provide tax, accounting or legal advice. Clients should review any planned financial transactions or arrangements that may have tax, accounting or legal implications with their personal professional advisors.
Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.