Fixed income investors have been complaining about low interest rates for some time now. Federal Reserve Chairman Ben Bernanke didn’t help their cause earlier this year when he said interest rates may stay low until 2014. This might be bad news for fixed income investors but it is great news for estate planning. Low interest rates create an ideal environment for transferring wealth to heirs through various advanced estate planning techniques.
Loaning money is one of the easiest ways to transfer money to your heirs. The IRS requires you to charge a minimum interest rate called the Applicable Federal Rate (AFR). The AFR is published each month on the IRS website. The AFR for April 2012 was 2.68% for long-term loans. You should have a written agreement with your heirs stating the rate of interest and maturity to avoid making the transaction look like a gift. The current gift tax exclusion is $13,000 per year, per person. You can simply forgive part of the loan each year as part of your annual gifting until it is paid off.
You can make a simple loan even more powerful with an advanced estate planning technique known as a Self-Cancelling Installment Note (SCIN). The SCIN allows you to sell an asset to an heir and finance the purchase through installment payments. Your heir must make payments while you are living, but all future payments would be forgiven upon your death. The SCIN has two objectives 1) avoiding inheritance tax on the asset; 2) exclusion of the unpaid loan balance in your estate which would minimize or eliminate any federal estate tax.
The current low AFR keeps the payments low while the loan is being repaid. The current gift tax exclusion allows you and your spouse to forgive up to $52,000 of a loan made to an heir and their spouse. The SCIN keeps the asset out of your estate should the loan not be forgiven over your lifetime.