By: Brian Tullio

The low-rate environment of the past several years has been a boon to many estate planning techniques and greatly benefited those looking to tax-efficiently transfer wealth.  However, 2022 has brought record high inflation, prompting the Federal Reserve to begin a campaign of interest rate increases in hopes of taming inflation momentum.  With the indication that rates could remain elevated for some time, different wealth transfer opportunities may be more effective now than those utilized in prior years.  Prudent planners should adapt accordingly, and a few such strategies are outlined below.


Qualified Personal Residence Trust (“QPRT”)

A QPRT can be particularly effective in a rising interest rate environment.  Generally, a QPRT allows you to gift your personal residence to a trust for the benefit of your family at a reduced gift tax cost while you retain the right to reside in your home for a period of years.  The QPRT helps reduce the size of your taxable estate as the full value of your home is transferred out of your estate at a gift cost equivalent to your remainder interest (term of years).  The calculation of the value of the remainder interest is based upon the Applicable Federal Rate (“AFR”) and as rates rise, the value of the remainder interest shrinks.  So, the higher the AFR, the lower the value of the remainder interest and corresponding taxable gift.  Ideally, this also occurs as home values increase, thereby keeping the appreciation out of your estate as well.

Something else to keep in mind when evaluating QPRTs is that the residence maintains a carryover basis when transferred from the trust to the beneficiary.  So, when the grantor dies, the basis of the residence is not stepped up.  Thus, this strategy may be ideal where removal of the taxable value of a residence outweighs any benefit conveyed by the stepped-up basis received by the grantor’s heirs.  So, higher basis homes (i.e., recently purchased) are excellent candidates for a QPRT.

Charitable Remainder Trusts (“CRT”)

For those individuals who are charitably inclined, a CRT may be an effective planning tool.  A CRT is a trust established during your lifetime that provides annual distributions to you or a beneficiary for a fixed term or over your lifetime, depending on whether an Annuity or Unitrust is utilized.  At the end of the trust term, the remaining assets are distributed to a charitable organization of your choosing.  You are entitled to a charitable income tax deduction in the year of the gift, which is equal to the remainder interest eventually distributed to the charitable organization.  This remainder interest must perpetually equal at least 10% of the fair market value of the trust’s assets, and is valued using the AFR.  Thus, higher interest rates increase the imputed value of the remainder interest passing to charity, which results in a larger charitable deduction.

Annual Gifting

Although intra-family loans tend to become less effective as interest rates rise, you can still make annual tax-free gifts of up to $16,000 (indexed for inflation).  Where higher interest rates may also cause depressed asset values, such circumstances are ideal for gifting lower-valued assets so future appreciation grows estate-tax free.

Roth Conversions

If higher interest rates lead to depressed asset values, it may be time to consider converting your IRA to a Roth IRA.  Because the income tax on converting a traditional IRA to a Roth is calculated using the value of the marketable securities in the account, there is no better time to make this conversion than when markets are down.

Trust Asset Swapping

When equity markets are in decline, it may be prudent to evaluate already funded irrevocable trusts for opportunities to substitute assets.  Swapping low-basis assets with those assets already contained in your taxable estate could result in a greater benefit via the step up at death.  Under certain circumstances, it could also be beneficial to structure those swaps as a sale whereby the trust sells lows basis assets to the grantor, thus trading cash for an asset eligible for a step up in basis.  Alternatively, swapping assets with high-growth potential from your estate to a trust in order to exclude future appreciation from your estate may also be prudent.

Depending on what the Fed’s “dot plot” may look like over the coming months, the effectiveness of the above planning techniques may increase or decrease.  Nonetheless, planners should always be mindful of fluctuations in interest rates and utilize the particular techniques most advantageous for their clients.