Estate Planning Strategies for Challenging Economic Times

  • Volatile financial markets, rising inflation, and interest rates moving higher can pose wealth planning challenges, but they can also provide windows of opportunity.
  • In this Wealth Planning Insights, we explore several wealth planning strategies that could be useful in the current difficult environment.
  • Now could be a good time to review your estate plan with your client advisor to see if one or more of these strategies could be appropriate for your situation.

Financial market volatility began to pick up at the end of 2021, and it has evolved into a broader market decline this year. The S&P 500, for instance, fell 8.4% in June and was down almost 21% for the first half of the year. The Nasdaq Composite, which tumbled more than 8% last month, was down 29.4% for the six-month period. And bonds, grappling with troubles of their own, haven’t been able to provide much protection from stock market woes.

While geopolitical conflict is certainly playing a role in current market tribulations, the principal driver of current volatility is the Fed’s sharp pivot toward tighter monetary policy and the potential impact on interest rates, inflation, and the outlook for the economy.

The economic environment has grown more challenging in recent months. U.S. inflation stood at an 9.1% annual rate for the 12 months ended June 2022, marking a new 40-year high.

At the same time, interest rates are moving higher. As its recent 75-basis-point increase to the federal funds rate attests, the Federal Reserve is focused on fighting inflation, and additional hikes are likely in the months ahead. Longer-term rates have adjusted as well, with the 10-year Treasury yield now about 3%.

While market volatility and economic uncertainty can be deeply unsettling, from a wealth planning perspective, depressed asset values can present a number of potentially useful opportunities. In the following sections, we explore several timely strategies that could be worth considering today.

Lifetime and Annual Exclusion Gifts

If you’re planning to make gifts using the lifetime or annual exclusion from the gift tax, it could be advantageous — given market volatility — to make them now with publicly traded securities suffering from a reduced value. (Gifts of interests in closely held companies could also be worthwhile but would require an appraisal by a valuation firm.) While the cost basis for capital gains will carry over (i.e., when sold, the recipient will use the donor’s basis to compute capital gains), any growth reflecting the return to a higher value will benefit the recipient directly at no tax cost to you. Alternatively, you could always give cash and allow the recipient to invest, or you could make the gifts to a grantor trust so that you continue to pay the income taxes on behalf of the trust.

It's also worth noting that inflation can bring at least some good news. Since the estate and gift tax exemption and the annual gift tax exclusion are both indexed for inflation, rising inflation can be beneficial because those amounts will increase at a faster rate:

  • The lifetime gift tax exemption, for example, was $11.7 million per person in 2021, and it has now increased to $12.06 million per person (more than $24 million for a married couple) in 2022. This is an increase of $360,000, a very large one-year jump. Since the exemption doubled from $5.49 million per person in 2017 to $11.18 million in 2018, a result of the Tax Cuts and Jobs Act, the average annual increase has been $170,000. To put this in perspective, just 20 years ago, the lifetime exemption amount per person was only $1,000,000. Given these inflationary adjustments, should you use your gift tax exemption immediately? As always, the key is not to overextend by making gifts you’re not ready to make. That said, if you can afford to use your exemption and are interested in making gifts, we encourage you to do so sooner rather than later because the exemption is likely to decrease in just a few years. (Under the current law, the gift tax exemption is scheduled to decrease on January 1, 2026, to $5 million per person indexed for inflation.) Volatile financial markets make this advice even more timely because, when values are depressed, you can leverage your gifts more effectively,
  • The annual gift tax exclusion was $15,000 per gift to an individual for the past four years, but for 2022, it is now $16,000 ($32,000 for a gift from a married couple to an individual).

Grantor Retained Annuity Trusts (GRATs)

Grantor retained annuity trusts (GRATs) remain an effective technique for transferring wealth free of estate and gift taxes. They involve transferring assets into a trust (usually short term, such as two years), while retaining an annuity repayment of most or all of the original principal plus an interest rate, known as the 7520 (for its section of the tax code) or “hurdle” rate. Any growth in the assets beyond the interest rate hurdle will be transferred free of estate or gift tax to the ultimate beneficiaries.

Two components make GRATs potentially timely:

First, the markets are volatile, and asset values are depressed. Imagine a stock that, based on fundamentals, should be trading at $100 per share. If market disruptions temporarily push the stock’s value down to $70 per share, one could transfer the stock at $70 into a GRAT; if the stock were then to revert to its $100 expected value once the market disruption has passed, this $30 increase (minus the Section 7520 rate interest cost) would be transferred free of estate or gift tax, avoiding a potential future 40% federal estate tax.

Second, the 7520 rate is rising but still low by historical standards; for example, GRATs funded in August will only need to outperform a 3.8% hurdle to pass a tax-free gift to the remainder beneficiaries.

Tax-Free Substitution of Growth Assets Into Grantor Trusts

Many clients have established irrevocable trusts that, for income tax purposes, qualify for grantor trust treatment. This means that the client is deemed to be the taxpayer, reporting the trust’s earnings on their tax return.

Assets may be exchanged between the trust and the person who funded the trust tax-free, if allowed under the terms of the trust instrument. Given the market changes, it makes sense to review the assets in your name as well as those in your grantor trusts to determine whether those with higher growth potential should be swapped into the trust (after considering basis and other factors).

Converting Traditional IRAs to Roth IRAs

Tax law permits conversion of traditional IRAs to Roth IRAs, thereby gaining more favorable tax treatment (the same tax-free growth as traditional IRAs, but also tax-free withdrawals after age 59½ and no required minimum distributions). Market volatility can make conversion timely, since the account owner must include in taxable income the value of the traditional IRA assets on the date of conversion to a Roth IRA. When the market forces those values lower, less tax is triggered. Another reason a Roth conversion could be timely is the potential for individual income tax increases down the road; conversions or required minimum distributions after any tax hikes would lead to a higher federal income tax bill. Although the recent changes in retirement account distribution rules have reduced the amount of time non-spousal beneficiaries can let assets compound in a tax-free or tax-deferred environment, Roth conversions can still be beneficial for those who are able to pay the income tax cost upon conversion from outside of their retirement account. Note that Roth conversions can be done piecemeal, and there is no limit to frequency or amount. Timing charitable contributions in the same year as a Roth conversion can help mitigate the related income tax and potentially maximize the marginal tax rate associated with the contribution.

Low Interest Rate Loans

In most circumstances, the tax code requires that loans be made with a minimum amount of interest — known as the applicable federal rate, or AFR — to avoid the loan being deemed a gift. If no (or a lesser) interest rate is charged, the tax code assigns the necessary amount and requires the lender to pay taxes on this hypothetical interest amount or the difference may be deemed a gift and subject to gift tax.

These minimum rates have been increasing, but they are still relatively low. As a result, it could still make sense to consider loan techniques that are more advantageous with low rates. These include, from the simple to the complex, techniques such as the following:

  • Making a low-rate loan directly to a child or grandchild or other individual
  • Making a low-rate loan to a grantor trust (including a GST-exempt trust), which invests the proceeds (the positive arbitrage on the difference between the investment returns and the amount of interest to be paid on the loan stays in the trust and is not subject to estate or gift tax)
  • Refinancing an existing loan to reduce the rate
  • Selling assets (which may have a lower than usual fair market value in today’s environment) to a trust in exchange for a promissory note using today’s low rates

Won’t Rising Interest Rates Negatively Affect These Planning Techniques?

In its efforts to fight inflation, the Federal Reserve has begun to raise the federal funds rate, the interest rate that banks charge each other for short-term loans. Typically, an increase in the federal funds (fed funds) rate has a chain-reaction effect on the entire interest rate market, with short-term markets most directly impacted. It also impacts the two primary interest-rate metrics used for estate planning: the AFR and the Section 7520 rate, the legally required rate for several estate planning strategies.

Both AFRs and the 7520 rate have been rising, but they are still well below historical averages. And with several of the strategies outlined above, the current rate can be locked in for a period of years. Even more important, these rates are much less significant than the long-term growth potential afforded by using depressed assets — many of which may be down 15% or more this year — for these strategies.

Now Is a Good Time to Review Your Estate Plan

We’ve presented a number of strategies likely to be most efficient in the current environment. If market dynamics shift or interest rates rise significantly from current levels, it may become necessary to reconsider some of these strategies. As always, we are monitoring developments closely and will adjust our approach as needed.

That said, the most appropriate wealth-transfer strategy for you obviously entails much more than a consideration of the macro environment. The decision to implement a new strategy today or wait, to reengineer one already in place, or to leverage the benefit of one already completed needs to be assessed in the full context of your circumstances and objectives — and with the assistance of experienced planning professionals.

Your advisors can help you weigh the potential benefits of different strategies and determine concrete actions to ensure that the maximum amount of your wealth will transfer tax efficiently to those persons and causes you wish to support.

This material is for your general information and educational purposes. The discussion of any estate or other planning observations herein is not intended as legal or tax advice and does not take into account the particular planning objectives, financial situation, or needs of individual clients. This material is based upon information obtained from various sources that Bessemer believes to be reliable, but Bessemer makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current only as of the date indicated and are subject to change as a result of new legislation or evolving case law.

Jaclyn G. Feffer

Senior Fiduciary Counsel

Jackie is responsible for working with clients and their advisors to develop practical and efficient wealth transfer plans, and for guiding the firm on fiduciary issues.

Patrick S. Boyle

Patrick S. Boyle

Region Head and Senior Investment Strategist

Patrick is responsible for Bessemer's client relationships in Washington, D.C., Atlanta, Delaware, and Philadelphia. In addition, he performs macroeconomic research and financial market analysis in order to deliver customized asset allocation and investment recommendations to clients.