A down market gives super-wealthy people the ability to use sophisticated strategies to help pass along billions of dollars to heirs, tax free, reports Accounting Today in the article “Heirs of ultra-wealthy can profit even when markets plunge.” Plunging interest rates and lower stock prices make it even easier to protect those mega-fortunes from the IRS. This also presents an opportunity to take a longer-term view of market volatility, because their beneficiaries are future generations, including family members who haven’t even been born yet.
Smart individuals, the ultra-wealthy or regular people, understand that this volatility could go on for several months. However, they are invested for a long-term market. However, the richer you are, the more you can insulate yourself from both the corona virus and its effects on the economy. The wealthy investor can use this opportunity to buy stocks at a low point, for instance, buying up stock from companies in travel-related industries.
The IRS levies a 40% estate and gift tax on the biggest fortunes, exempting transfers of $11.58 million for individuals and more than $23.16 million for married couples. Families with more wealth than that often use a Grantor Retained Annuity Trust, or GRAT, to pass money to their children and grandchildren.
Here’s how it works. Stock or other assets are placed in a GRAT, a transaction that is a loan. If the stock rises in value, the proceeds go to the beneficiaries, tax-free. If the stock drops, no harm—the shares go back to the donor. It’s a win-win for those who can use this tool, regardless of their amount of wealth.
One reason for the popularity of the GRAT is that when markets decline, there are more upsides to the assets in a GRAT. This is also the time when people who have old GRATs with losses, may want to give up on them. GRATs with even small initial losses are now unlikely to succeed. It’s better to start over with new GRATs.
Plunging interest rates are another reason for the new attention on GRATs. When taxpayers loan money to set up GRATs or other trusts, the IRS requires that the trusts pay interest back to the lender. The rates, which are set by a formula and published each month, are a hurdle that GRAT investments must clear for returns to flow to the beneficiary. The hurdle rate for a typical GRAT has fallen by half since the end of 2018 and to 1.8% this month. That’s not counting the impact of the Fed’s surprise rate cut. With Treasury yields hitting record lows, the April rate could drop to 1.2 percent, or even lower.
Similar IRS rules apply to loans within families, another popular strategy used to pass wealth while avoiding the estate tax. As the IRS-required rates drop, advisors say they are helping wealthy families refinance loans, so heirs and trusts are paying less back to their benefactors, usually parents or grandparents.
Reference: Accounting Today (March 6, 2020) “Heirs of ultra-wealthy can profit even when markets plunge”
Suggested Key Terms: Market Volatility, Beneficiary, GRAT, Grantor Retained Annuity Trust, IRS, Estate Tax, Interest Rates, Refinance, Loans, Corona Virus