With the IRS’s monthly interest rate at its lowest level on record at 1.4 percent, the stock market down and housing values depressed, this is a prime time to maximize tax-saving wealth transfer strategies.
“The effectiveness of many strategies depends on being able to get a higher rate of return than the IRS interest rate – now, with the rate so low, and values depressed, that shouldn’t be hard to do,” says Alan Augulis, an estate planning attorney in Warren Township, N.J.
People of modest wealth shouldn’t assume they won’t be affected by estate taxes. Even though the current federal 35 percent estate tax kicks in on estates topping $5 million (or $10 million for couples), in 2013 the federal estate tax exemption is scheduled to drop to $1 million, and the tax rate will jump to 55 percent unless Congress acts.
What’s more, 17 states and the District have their own estate taxes. In the District and most of those states, such as Maryland, New York, Massachusetts and Oregon, the tax kicks in on estates valued at more than $1 million. But only $675,000 is exempt from the estate tax in New Jersey, $338,333 in Ohio and $850,000 in Rhode Island. Most states with estate taxes charge a top rate of 16 percent. The District’s is the highest, at 19 percent.
When you consider everything included in an estate — your home, car, retirement accounts — it can all add up pretty quickly beyond those exemption levels. “Yet you would be amazed at how many people don’t plan for the estate tax,” says Steve Lewit, CEO of Wealth Financial Group in Chicago.
One of the simplest ways to pass on assets is through piecemeal gifting. Every year you can give away $13,000 to as many individuals as you like, tax-free. So if you and your spouse have three children, you can combine your exclusion to give $26,000 to each.
But unless you’re super-wealthy, you may be hesitant to give money away given the uncertainties of the economy and the markets. “Even wealthy people are concerned about outliving their money these days,” says Robert Katz, partner in charge of wealth strategies at Bainco International Investors in Boston.
As an alternative, there are ways to let your assets appreciate in your children’s names without actually giving them up.
Intra-family loans are the most basic example. Just like any loan, an intra-family loan must be repaid with interest after a specified period of time. The interest can be paid regularly or as a balloon payment at the end of the loan term.
Loans, so as not to be subject to the gift tax, must be arranged with interest. Each month the IRS sets the interest rates called the Applicable Federal Rates. For October, the rate used in many wealth-transfer maneuvers is 1.4 percent, but for intra-family loans they can be even lower depending on the term: The rate is 0.16 percent for short-term loans of three years or less, 1.19 percent for loan terms of four to nine years, and 2.95 percent for 10 years or more.