Heirs of the UHNW can profit even when markets plunge

While the IRS levies a 40% estate and gift tax on the biggest fortunes, some of the wealthiest clients may consider the grantor retained annuity trust, or GRAT, to pass money to children and grandchildren tax-free.
While the IRS levies a 40% estate and gift tax on the biggest fortunes, some of the wealthiest clients may consider the grantor retained annuity trust, or GRAT, to pass money to children and grandchildren tax-free.
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The worldwide worry over coronavirus creates a glimmer of good news for at least one segment of the U.S. population: the top 0.1%.

The super-wealthy can deploy sophisticated strategies to pass on billions of dollars to their descendants tax-free. Plunging interest rates, combined with lower stock prices, make it even easier to protect those fortunes from the IRS.

The ultra-rich and their advisors can also take a longer-term view of market volatility because their beneficiaries are future generations — some who haven’t even been born yet.

“They have more money than they could ever spend,” Ali Hutchinson, a senior wealth planner at Brown Brothers Harriman, said of her clients. “Even though this volatility could go on for months, they’re not thinking about it in that short-term way. The smart ones are using it as an opportunity.”

The richer you are, the more options you have to insulate yourself from the virus and its effects. Operators of private jets are seeing more demand from wealthy travelers reluctant to fly commercial. Members of the top 0.1% say they’re in close touch with world-class doctors and are considering fleeing to remote vacation homes in the event of a serious outbreak.

The virus can also be a chance for the wealthy to make money. The most intuitive way is to buy beaten-down stocks in industries like airlines and hotels that are being damaged by the virus but will ultimately survive even a devastating pandemic.

“Are people going to travel in 10 years?” Hutchinson asks rhetorically.

Using the financial turmoil to avoid taxes requires more complex planning. But lower rates and market valuations make this an ideal time to try, advisors to the wealthy say.

“You could almost say it’s a perfect storm for wealth-transfer planning,” said David Stein, a partner on the private client and tax team at Withersworldwide.

The IRS levies a 40% estate and gift tax on the biggest fortunes, exempting transfers of $11.6 million in 2020 for individuals and more than $23 million for married couples. For Americans richer than that, a popular tool to pass money to children and grandchildren tax-free is the grantor retained annuity trust, or GRAT.

Here’s how it works: A rich family will put a stock or other asset in a GRAT, a transaction that is technically a loan. If the stock rises in value, those proceeds go to beneficiaries tax-free. If the stock drops, there’s no harm done — shares just go back to the donor.

“It’s not ‘heads I win, tails I lose,’ it’s ‘heads I win, tails I break even,’” Stein said. Clients often set up multiple GRATs holding different investments, creating new ones whenever old trusts expire.

While they’re already widely used, “it’s a time when a lot of folks are looking at doing GRATs,” said Bryan Kirk, director of financial and estate planning at Fiduciary Trust International.

One reason is market declines, which give assets in GRATs more upside potential. BBH’s Hutchinson also is advising clients to give up on old GRATs that have losses. She cites research by her firm showing that GRATs with even small initial losses are unlikely to succeed over their life. It’s better to start over with new GRATs, seeded with stocks now trading at lower valuations.

Plunging interest rates are another reason for new attention on GRATs. When taxpayers loan money to set up GRATs or other trusts, the IRS requires that 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 in order for returns to flow to beneficiaries.

The hurdle rate for a typical GRAT has fallen by half since the end of 2018, to 1.8% this month. That doesn’t reflect the impact of the Fed’s surprise rate cut on Tuesday. With Treasury yields hitting record lows, Stein expects the IRS’s April rate could drop to about 1.2% or even lower.

That means the wealthy may be tempted to wait until next month to start GRATs, though advisors say timing the market well is ultimately more advantageous than grabbing a slightly lower interest rate. “The thing that really makes a difference is what happens to asset values,” Fiduciary Trust’s Kirk said.

Similar IRS rules apply to loans within families, another popular strategy to pass on wealth while avoiding the estate tax. As the IRS-required rates drop, advisors say they’re helping rich families refinance those loans, so heirs and their trusts are paying less back to benefactors. Kirk also expects his clients to make more new loans to children and grandchildren, giving next generations the cash to ride out volatility.

“A lot of people don’t want to sell when the market is down,” Kirk said. “If they need liquidity, borrowing from an older generation that has cash available is an option.”

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