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Legal Update

Record Low Interest Rates Present Estate Planning Opportunities

12 May 2008
Mayer Brown Legal Update
The combination of low interest rates and current economic conditions present an excellent opportunity for the transfer of wealth to children and others. The IRS recently announced the May interest rates that are applicable to intra‐family loans and more sophisticated techniques, such as grantor retained annuity trusts (GRATs), and they are the lowest they have been in many years. These low rates allow a person to make a substantial loan to another person, or to transfer assets to a trust (such as a GRAT) that will benefit that person in the future, all with no gift tax consequences. Although this Client Alert contemplates a parent benefiting a child, keep in mind that these techniques can generally be used by anyone to benefit another person.

Low‐Interest Loans to a Child

A parent can make a loan to a child at a very low rate of interest. This can enable the child to pay off a mortgage or other debt, or to invest for a greater return. The loan could be structured to require the child to pay the parent only the interest due, or the loan can be amortized so that the principal is reduced over time. For there to be no gift tax as a result of the loan, if the loan is made in May 2008 and interest is compounded annually, the parent would be required to charge the following minimum rates of interest:
  • Loan with a term of three years or less: 1.64%
  • Loan with a term of three to nine years: 2.74%
  • Loan with a term of more than nine years: 4.21%
An intra‐family loan is easily documented and can be secured by a mortgage, which might allow the child to deduct the interest each year as an itemized deduction. It is an especially attractive technique for a parent who has already used his or her gift tax exemption and can no longer make substantial tax‐free gifts to the child, but still wishes to assist the child financially.

Effective Wealth Transfer Through a Grantor Retained Annuity Trust (GRAT)

Effective wealth transfer techniques are a vital part of maintaining and maximizing family wealth. One of the most popular is the GRAT, which allows a parent to transfer wealth (generally in the form of asset appreciation) to a child while still receiving, in the form of an annuity, income and a return of the value of the property initially transferred to the GRAT. The GRAT offers significant wealth transfer tax planning opportunities, especially in the current low interest rate environment. If properly structured, there will be no federal transfer taxes as a result of the GRAT. For a GRAT established in May 2008, the IRS assumes appreciation at a rate of 3.2 percent. If the actual appreciation is greater than 3.2 percent, then that excess value passes to the child, or another beneficiary, tax‐free.

General Description

A GRAT is a trust in which the grantor retains the right to receive an annuity until the end of a term of years. The annuity is a fixed amount, which is often a percentage of the value of the property initially transferred to the GRAT. The annuity can also be a fixed amount that increases by 20 percent per year. The annuity must be payable at least annually. If the grantor is living at the end of the GRAT’s term, the balance of the trust property is either distributed outright to the beneficiaries designated under the trust instrument — generally, the grantor’s children — or is held in trust for their benefit. If the grantor dies before the end of the term, the GRAT will continue to pay the annuity to the grantor’s estate until the end of the term, at which time the trust property will pass to the designated beneficiaries. The grantor generally can act as the trustee of the GRAT.

Planning Opportunities Using GRATs

When properly structured, GRATs have little tax risk and a potential for significant tax savings and wealth transfer. As is discussed below, a GRAT can be structured as a “zeroed‐out” GRAT so that there is no taxable gift when it is created. There are no adverse federal tax consequences if the GRAT “underperforms” and has to distribute assets in kind (rather than cash) to meet the required annuity payments. If no trust property is left at the end of the term to distribute to the beneficiaries, the grantor, who has had the use of the assets, is no worse off than if the grantor had not created the GRAT in the first place. Even if the grantor dies before the end of the GRAT’s term, there should be no greater federal estate tax than if the grantor had not created the GRAT. A GRAT makes “tax sense” if there is a reasonable likelihood that the trust property to be held in the GRAT will produce a total return substantially greater than the applicable discount rate for the month during which the GRAT is created. This discount rate changes monthly, but for May 2008 it is only 3.2 percent.


In May 2008, you transfer assets valued at $5 million to a 6‐year GRAT. The discount rate is 3.2 percent. You are the Trustee of the GRAT, and the GRAT is structured as a zeroed‐out GRAT, so the transfer to the GRAT will not be treated as a gift. Annual annuity payments that increase 20 percent per year will be made to you, so you will receive an annuity payment from the GRAT of approximately $570,000 in the first year, increasing 20 percent each year, culminating in an annuity of approximately $1.4 million in the final year. You will receive a total of approximately $5.7 million in annuity payments over the term of the GRAT. If the assets in the GRAT appreciate at a rate of 8 percent per year, then after six years the GRAT will terminate and approximately $1.3 million will be distributed to your children, either outright or in trust for their benefit, tax‐free.

Federal Gift and Estate Tax Consequences

It is now possible to create a GRAT without utilizing any gift tax exemption or incurring any gift tax liability. Furthermore, there are no gift tax consequences upon termination. If the grantor survives until the end of the term of the GRAT, then the value of the trust property is removed from the grantor’s gross estate for federal estate tax purposes. However, if the grantor dies before the end of the term, then substantially all of the trust property in the GRAT will be included in the grantor’s gross estate for federal estate tax purposes.

Federal Income Tax Consequences

A GRAT should be a “grantor trust” for federal income tax purposes. As such, the grantor is treated as the owner of the trust property, and all income of the GRAT, if any, would be taxable to the grantor during the term of the GRAT. Because the GRAT is a grantor trust, there are a number of favorable tax consequences. The grantor should be able to exchange assets with the GRAT and receive distributions of low basis assets as payment of the annuity without any income tax consequences. Further, the grantor’s payment of income tax on GRAT income may further benefit the ultimate beneficiaries. For example, the grantor might transfer low basis assets to the GRAT and then sell them during the term of the GRAT, leaving cash instead of low basis assets for the ultimate beneficiaries, without further gift or estate tax consequences to the grantor.


  • Donna E. Morgan
    T +1 312 701 7138
  • Richard A. Campbell
    T +1 312 701 7111
  • James A. Casey
    T +1 312 701 8670
  • Daniel W. Luther
    T +1 312 701 7137

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