Wealth Strategies to Consider and Avoid During a High Interest Rate Environment

Financial Planning

 Susan Jones By: Susan Jones
Wealth Strategies to Consider and Avoid During a High Interest Rate Environment
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It’s hard to escape how high interest rates are dominating the economic and financial news cycle these days. Sustained higher interest rates have been paired with high inflation, focusing media coverage on negatives like a higher bill at the grocery store or the impact on the housing market and ability to borrow money.  

If you just read the news, you could easily think your wealth building strategies are off the table for now. Here’s what the headlines are missing:

Yes, interest rates and inflation are high, but the market is also high. Rather than put every wealth-building goal on hold, we’ll outline some unique strategies that might prove more impactful in this economic environment.   

In short, we’ll share ways to make the best of this situation as well as cover a few items that are best to wait to accomplish until rates come down.  

Interest Rates, Inflation & Bear Markets 

Up front, it’s important to level set that sometimes we can conflate a high interest rate environment with a down market or “bear market.” The reality is although interest rates, inflation, and the market trend are related, that does not mean that there is a perfect correlation. 

The last few years have been a great example of higher interest and inflation, but a growing market. Compare this to a very different situation in 2008 during the housing crisis where a volatile market was paired with high unemployment and thus a bottoming out of rates and inflation.

We clarify this mostly to say that each market environment can provide unique risks and opportunities, and there isn’t a one-size-fits-all approach.  

Harnessing the Benefits of a Qualified Personal Residence Trust (QPRT) 

One example of a financial trust tool with potential to drive higher impact during our current environment is a Qualified Personal Residence Trust (QPRT). This is an estate tax strategy sanctioned by the IRS code that is one type of split interest trust 

A QPRT is a great strategy for cutting gift taxes. With a QPRT, you can gift a home into a trust at a greatly reduced value, resulting in lower gift tax. 

This becomes important when developing a generational wealth transfer strategy that doesn’t create an unnecessarily large tax burden on a benefactor who may or may not be as financially solvent.

Furthermore, one of the most appealing factors in a QPRT is your right to continue living in the home for a number of years, known as the retained term. 

This clause makes for an appealing transfer method that doesn’t require you to move out or make other disruptive logistical changes. Even after the retained term ends, you can typically still live in or rent out the property depending on the specific provisions in your QPRT. 

What makes now a high-value time to pursue this strategy? QPRTs can be particularly beneficial when interest rates are high because of how the gift tax value is calculated—giving more value to the grantor’s ability to remain in the home.  

The higher the IRS interest rate, the lower the actual gift tax is. Simply stated: math works in your favor while rates are high, making a trust transfer strategy that is already appealing for those looking to transfer property more favorable. 

Charitable Remainder Trusts (CRT) for Asset Management 

Similarly, another type of split interest trust is called a Charitable Remainder Trust (CRT) 

A CRT allows the grantor to gift assets to the trust during their life, while maintaining the ability to receive annual distributions. At the grantor’s death, the remaining assets go to a charitable beneficiary of the grantor’s choice.  

When a CRT is formed, the grantor is entitled to a charitable income tax deduction. The perfect alignment occurs for those who have a desire to grow their charitable impact and an asset that might usually incur a larger tax bill.  

For example, CRTs are generally recommended if someone has a concentrated stock position. Why? The CRT itself is not a taxable entity, so although the income distributions are eventually taxable, it can be a great way to minimize the amount of tax that is paid and while creating a diversified portfolio and achieving pre-tax charitable giving goals. 

Similar to a QPRT, the math can work in your favor in a high interest rate environment because the income tax deduction value is equal to the amount of the assets that ultimately pass to charity, using IRS prescribed interest rates. The higher those interest rates go, the higher the gift to charity is deemed to be—and higher the income tax deduction is for the grantor when the trust is established and funded. 

Intra-Family Loans: Pros & Cons  

There is nuance to if and when intra-family loans can be a benefit to your financial plan or to the plans of the recipients. Sometimes, because you may be trying to help others achieve their goals, the standard may simply be trying to minimize any negative impact. 

Here’s the bad news: In order for an intra-family loan to not count as a gift, you must enact an interest rate that matches or exceeds the IRS interest rate, which currently is at a more than 10-year high. 

The good news is that this can still be a mutually beneficial transaction within a family because the mandated interest rates are often lower than what someone can find commercially. The recipient can get a more favorable loan term and you can support a family member without majorly impacting your financial plan. You also retain the option to refinance later on. 

Proceed With Caution: Wealth Strategies to Postpone or Avoid During High-Interest Periods 

Now that we’ve walked through some wealth-building strategies that are actually beneficial during high interest rate environments, it’s important to equally stay cautious about certain planning tools that are best saved for when rates come down a bit.  

If you can wait to employ some of these strategies, it can bolster the effectiveness in the long run to do it when rates stabilize.  

Grantor Retained Annuity Trusts (GRATs) 

A GRAT lowers taxes for big gifts to families. The grantor puts assets in the trust and gets a yearly annuity. After a set time, the leftover assets go to beneficiaries, often tax-free. 

Simply put, a GRAT lowers taxes on big gifts within families, particularly to the next generation. You can dig into the specifics how this Trust strategy works in this piece, but the important thing to call out now is that for this to be effective, the assets need to grow faster than the IRS rate. In high-interest periods, this is less of a sure thing. If rates out-pace growth, the benefits shrink and tax reduction might not be enough to make it valuable.  

Charitable Lead Trusts (CLTs) 

Consider CLTs the inverse of Charitable Remainder Trusts. They give income to a charity for a while, then pass the rest to family. While strategically this may be what someone hopes to accomplish, the inverse of the high interest rate benefits for CRTs is also true.  

High IRS rates mean less tax deduction and higher taxable gifts, saddling a benefactor with a tax burden. For this reason, it might be best to wait until rates stabilize if this is looking appealing. Working with a financial advisor can help you identify optimal times to enact various long-term planning strategies.  

Closing Thoughts: Is Every Tax Strategy Relevant?  

If you look back at the historical interest rate trends over the last 30 years, you understand just how low rates held through the last decade or so. Adapting to high interest rates requires thought and at times quick action, but it’s important to remember that just because a tax or financial planning strategy exists doesn’t mean it is right for you.  

The winning combination is a trifecta of achieving financial goal you already had more favorably, a market environment that enhances benefits, and it being relevant to your stage of life. For example, a favorable gift tax strategy today might be completely irrelevant if you are in your 30’s with no children. 

A good advisor will exploit all tax advantages to try to cut your next tax bill, but a great advisor will zero in on what makes the biggest impact on your lifetime tax liability while also achieving your goals. If you have a question about a tax strategy you’d like to get deeper insight on, book a consultation with a member of our team. 

Not sure where to start? Our financial plan analysis only takes a few minutes and delivers instant results on strengths and opportunities within your plan.  

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For over twenty years, Susan has passionately provided wealth management services to individuals, families, fiduciaries, private foundations and their related entities with a focus on sophisticated income, gift and estate tax consulting and compliance, proactive executive compensation planning and succession planning. Susan understands the many facets involved in creating a successful multi-generational family legacy and uses a forward-looking approach to help clients grow and preserve assets, reduce taxes and realize both their financial and non-financial goals. Susan’s experience includes practicing law in the tax and estate planning. More »

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