Stars Align for Some Special Wealth Planning Opportunities

A confluence of special tax, interest rate and market circumstances makes this a great time to execute income and wealth planning strategies that can help swing a year of concern into a year of opportunity.

An empty picture frame outlines a peaceful scene of a country road.
(Image credit: Getty Images)

As we enter the fourth month of an ever-evolving reality, we are slowly recognizing that many old norms are being replaced with the need for pragmatism and a levelheaded intellectual approach.

Every day we hear often conflicting information regarding our safety and the battle between economic salvation and the health of society. Even as unemployment reached levels not seen since the Great Depression, the stock market has returned to pre-virus levels . Meanwhile, the talking heads on the stock market TV shows still dole out advice on everything from what stocks are hot or cold to tax and wealth planning ideas, all of which leave the viewer confused and potentially frozen.

Right now, the greatest unknown is where we find ourselves within the progression of this perfect economic storm. Are we at the beginning? The middle? The end? Given this environment I thought it would be worthwhile to provide an analytical framework to approach a few wealth planning concepts that should be reviewed and analyzed based on your personal tax and financial situation.

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No one has a crystal ball, but there are variables that may be changing that we should consider from an opportunity perspective:

  • Income tax rates are at historic lows.
  • Interest rates are at historic lows, including the government sanctioned transactional interest rates, the “Applicable Federal Rates (AFR)” rates, used for many planning strategies.
  • The estate and gift tax exemption are at historic highs resulting in only 2 out of 1,000 estates being subject to the estate tax.

On the other side of the variable perspective:

  • The budget deficit is almost $3 trillion and could rise further depending on stimulus measures.
  • The national debt – over $26 trillion – will potentially eclipse our nation’s annual economic output, rising to over 100% of GDP.
  • The estate tax will automatically revert to more onerous levels in 2026, if not sooner.
  • We are in an election year in which politicians will have to admit the high likelihood of future income tax increases to pay for the deficit.
  • Many businesses are under economic stress, resulting in depressed valuations.

Given this financial picture, you can see why 2020 may be a perfect year to execute income and wealth planning strategies and swing a year of concern into a year of opportunity!

Although everyone’s situation is different, we wanted to introduce several planning concepts worth considering, depending on your own specific business and family situation and outlook regarding the future of taxes and political winds.

Is a Roth conversion right for you? Maybe yes, maybe no.

It was estimated in 2018 that tax-deferred retirement assets in the U.S. were in excess of $28 trillion! This creates a ripe tax revenue target for politicians trying to reduce the deficit. There has been significant press regarding such tax strategies as Roth conversions, which – by paying the deferred taxes on your IRAs today – result in the creation of tax-free Roth accounts that can grow tax free going forward.

However, the reality is that such conversions may not make sense for many taxpayers.

To make sense, there must be sufficient anticipated excess after tax returns in the Roth to warrant prepaying the future tax liability early. Each situation must be analyzed individually, with calculations made to justify the accelerated expense taking into consideration anticipated future tax rates, investment returns and deferral horizon.

Here is a glimpse at what needs to be considered in your Roth conversion decision:

  • As the key variable is the length of the future deferral period, converting when younger is typically better than when older.
  • If an individual is nearing retirement age and the retirement assets will be needed to fund retirement, this typically results in a shorter deferral period and the lower likelihood of an advantageous conversion.
  • On the other hand, if the retirement assets are not needed to fund retirement needs, the conversion can create additional saving opportunities as Roth accounts do not have mandatory minimum distribution requirements. If the goal is to leave such assets to the next generation, this allows a longer deferral period and the ability to leave heirs tax-free assets. Furthermore, if the retirement account owner will be subject to a future estate tax, the payment of the income tax before death reduces the estate, making such conversions even more economical.
  • With many business owners experiencing operating losses, timing a conversion to take advantage of otherwise unused pass-through operating losses could make sense. This assumes no other use for the business losses at the individual level.
  • Combining a conversion with a significant charitable contribution can reduce that tax cost and help justify the conversion, assuming there was a charitable intent irrespective of the conversion.
  • Anticipated future individual tax rate increases would be another significant factor to possibly warrant a conversion.

The key: Run the numbers before jumping to a conclusion!

See if the low-rate environment offers you an opportunity

A second planning strategy that can be simple to implement is using the low-interest-rate environment reflected in the IRS-sanctioned AFR rates to arbitrage returns in order to both shift wealth and potential income to future generations.

This concept can be as easy as making low-AFR-rate loans to loved ones or as complex as transferring low-basis and depressed investments via a “sale to an intentionally defective grantor trust (IDGT)” via an installment sale.

Today’s low-interest AFR rates allow a parent to make a long-term loan (over nine years) to a child at an interest rate of just 1.01% (June 2020 AFR) with any investment return over the stated loan rate accruing to the child. This is commonly referred to as an estate freeze transaction because the parent’s estate is fixed at the loan amount plus interest with all growth transferring to the child free of gift or estate taxes.

If the parent has low-basis assets, they can use a similar but more complex concept to sell the assets to a special kind of trust (IDGT); this requires professional guidance. For income tax purposes an IDGT is deemed to be a grantor trust owned by the parent and essentially ignored for income tax purposes, but if properly drafted removed from the parent’s estate for estate tax purposes, allowing the growth of the principal to escape the parent’s estate.

The sale to the IDGT must be at fair market value, but the sale is ignored for income tax imposition purposes with all growth above the interest rate on the installment note accruing to the trust beneficiaries. This latter concept can be used to transfer ownership in closely held businesses or investments that currently have temporarily depressed values due to the business environment.

These strategies can protect against an increase in estate taxes and can have income tax advantages as well. Using the IDGT strategy is one of the most powerful wealth-transfer strategies currently available for all the above reasons.

The June AFR rates are at historic lows with the short-term rate (under three years) being 0.18%; the mid-term rate (three to nine years) being 0.43% and the long-term rate (over nine years) being 1.01%. In addition, the IRS monthly AFR rate tables provide a minimum allowable interest rate to be used for present value and various valuation purposes, referred to as the 7520 rate. For June, this rate is only 0.60%, which for an annuity translates into a lower imputed annuity value and a higher residual value. For larger estates this allows a significant opportunity to transfer value via the use of Grantor Retained Annuity Trusts (GRATs) as any return over the 0.60% belongs to the trust beneficiaries without the imposition of gift or transfer taxes.

These low rates can also be used for philanthropic purposes by using Charitable Remainder Trusts in that the charitable deduction is higher the lower the rate used to value the annuity.

Possibilities for business owners

For those of you who own a business or business-related real estate, the economic disruptions have created pain. But, assuming the business will recover, there are opportunities available and now is an excellent time to have the business appraised and consider potential wealth-transfer opportunities (using a sale to an IDGT, discussed previously, is an ideal strategy).

In addition to wealth transfer, understanding and having a supportable valuation can be helpful when considering various income tax planning strategies, including restructuring from a tax efficiency viewpoint.

Act now

It’s not just a call to action, but a way to move forward as we navigate through these uncertain times. The above strategies are just a few to consider in today’s environment, which take advantage of low interest rates, depressed values, and the potential of higher taxes in the future. The key is act before it is too late!

This article is for informational purposes only. It is not intended as investment or tax advice and does not address or account for individual investor/taxpayer circumstances. Please click here for important additional disclosures.


This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Andrew Bass, CPA, CWM, PFS
Chief Wealth Officer, Telemus

As the chief wealth officer, Andrew Bass is responsible for all strategic financial and life management services of Telemus. He works with high-net-worth members to ensure their financial life plans are designed to achieve realistic goals in both the short and long term.