To say 2020 has been a challenging year is surely an understatement, and we are only halfway through! The combined impact of the global coronavirus pandemic and widespread social upheaval has been momentous. Understandably, for many, investing and financial matters have taken a backseat to current events. If you do find time to think about your planning, here are a number of opportunities you might find compelling.
It may be a while before we know the full cost of the coronavirus relief packages, but thus far the estimated total cost of the four separate packages is $3 trillion.1 That’s Trillion with a “T!” By comparison, the 2009 stimulus package had a cost of $831 billion. To put that in further perspective, 2019 federal revenues totaled $3.5 trillion. The CARES package alone (just one of the four packages passed) will consume nearly all of those revenues.
Even before the pandemic hit, the Congressional Budget Office (CBO) was projecting a budget deficit of approximately $1 trillion for the fiscal year. Partisanship aside, you have to be left wondering, “How will we pay for all of this?” Federal revenues come from three main sources: personal income taxes, payroll taxes, and corporate income taxes. Unless Congress develops an appetite for massive government spending cuts in future budget years, it isn’t unreasonable to believe that federal tax rates on income may increase in the coming years.
Roth IRA Conversions
Consider converting your traditional IRA balance to a Roth IRA. Also known as a Roth conversion, this transaction will trigger tax today on the amount converted. This might be attractive if you think your future income tax rate will be higher than your current income tax rate. It is important that you are able to pay the tax due from the conversion using non-IRA assets.
If your IRA balance has been reduced by the recent market decline, this may make the timing for a Roth conversion more attractive.
The CARES Act allows individuals to fully deduct up to 100% of their AGI for charitable gifts of cash that are made directly to public charities in 2020. (Previously you were limited to just 60% of your AGI.) Appreciated securities are still subject to a limit of 30% of your AGI, but you can “stack” cash and stock gifts to still achieve a deduction of 100% of your AGI.
*Note: Gifts to private foundations, supporting organizations, and donor advised funds are still subject to the same cash and appreciated securities limits as in 2019.
Pairing Roth conversions and charitable gifts in the same tax year might make sense. If you are charitably inclined, a large cash gift to charity could offset much or even all your income tax liability resulting from a Roth IRA conversion.
Required Minimum Distributions
For 2020, if you have reached your required distribution age, you are not required to take a distribution from employer plans and traditional IRAs.
The applicable federal rate (AFR) is the minimum interest rate that the IRS allows for private loans (as opposed to bank-funded loans). The AFR rates for June 2020 are at historic lows: short-term loans–0.18%; mid-term loans–0.43%; long-term loans–1.01%. See chart below for recent history.2
Source: http://www.tigertables.com/7520.htm and https://apps.irs.gov/app/picklist/list/federalRates.htm
With rates this low, loans to family members are almost “free.” For example, if you have children or heirs who have a near-term cash need and you can afford to part with the cash, you might consider serving as their lender rather than sending them to a bank.
If you have an existing private/intra-family loan, you might offer to refinance for them, though it may require they pay down the balance a bit in exchange.
Asset Sales to Trusts
Consider a sale to an intentionally defective grantor trust in exchange for a note.
Private loans can be used for moving illiquid assets out of a taxable estate to the next generation at a discounted valuation, using little to no lifetime exemption.
Loans to Beneficiaries
You can also consider loans to beneficiaries from trusts where you are the trustee.
An installment sale requires the buyer to make regular payments (installments) plus interest to the seller. At a low AFR, less interest is due back to the seller over the term of the sale. The sale allows for the partial deferral of any capital gain to future tax years by the seller and can help the seller keep their income within a desired tax bracket.
Section 7520 Rate
The Section 7520 Rate is used to discount the value of annuities, life estates, and remainders to present value. Named after the section of the IRS Code that defines it, this rate is based on the AFR rate. Therefore, it follows that when the AFR is at an all-time low so, too, is the Section 7520 rate. For the month of June 2020, the Section 7520 Rate is 0.8%.3
Often referred to as an “estate freeze” transaction, grantor retained annuity trusts (GRATs) can be used to transfer the future appreciation on assets to the next generation, gift-tax free. GRATS may be especially useful for transferring assets with high appreciation potential over the term of the trust.
A trust is created by the grantor who transfers assets into the trust. The trust pays an annuity back to the grantor for the term of the trust. The annuity payment is determined by using the Section 7520 rate at the time of the trust creation. As mentioned, the 7520 rate is quite low today. To the extent the assets in the trust grow at a rate that exceeds the 7520 rate, there will be assets remaining in the trust at the end of the term. These assets will pass to the beneficiaries without being taxed.
Charitable lead trusts (CLT) are also most attractive when the Section 7520 rate is low.
A CLT makes payments to a charitable beneficiary for a stated term. When the charitable distribution period ends, remaining trust assets are distributed to the beneficiaries, typically heirs of the grantor.
The charitable distribution amount is based on the Section 7520 rate at the time of the trust creation. When the rate is low, the charitable deduction the grantor can claim is higher and the remainder interest—the reportable gift to heirs—is lower.
The present value of the remainder interest is a taxable gift made by the grantor, using a portion of the grantor’s lifetime exemption amount. The lower remainder interest therefore means a smaller taxable gift.
The strategies mentioned in this article are not intended for everyone and this is not intended to be a comprehensive list. If you would like to learn more about how any of these strategies may be applied to your specific situation, please give us a call. As always, please seek advice from your accountant or estate planning attorney before taking any action on these ideas.