This week, the Treasury Department
released the November Applicable Federal Rate (AFR) - sometimes called the
Section 7520 rate - and it continues at its historic low of 1.4%. The AFR is the rate used to calculate the charitable benefit of gift arrangements that have an interest to the donor - charitable gift annuities, charitable remainder and lead trusts, and retained life estates. (The Wall Street Journal recently featured
an article about charitable and non-charitable techniques to explore in a low-rate environment.)
While a low AFR rate is not great for gift annuities and remainder trusts, it's great for lead trusts and retained life estates. Combined with the current gift tax exemption amount and with depressed asset values, a non-grantor lead trust can be a powerful tool to leverage the transfer of assets to the next generation, provided the client is philanthropically inclined.
This becomes especially important for clients who are relatively young and whose estates may not be at $10 million yet - but could possibly be at that threshold in the future. Why not transfer assets out of the estate now, taking advantage of the low AFR?
Here's how it could work. Take a family in which the parents are in their 60s with a net worth of $12 million. They have assets depressed from the recent downturn, they are charitably inclined, and are uncertain about the estate tax outlook after 2012.
If that family were to transfer $3 million (25% of their estate) into a 20-year charitable lead annuity trust, that trust would only need a payout rate of 5.76% to achieve a zero-tax result. In other words, paying income to charity for 20 years at 5.76% with today's 1.4% AFR would result in a $3 million gift tax deduction. The donor/client would not have to use up any of their lifetime exemption.
When the AFR was higher two years ago, the same gift would require a charitable payout of 6.85%.
Remember that when establishing a gift that requires use of the AFR, you have the option of choosing the current month's rate or making an election to use either of the two preceding months' rate, whichever is most advantageous. Gifts made in January 2012 can still take advantage of the November 2011 AFR if the rate starts inching upward again.
Now is a great time to check in with your clients who have the goal of transferring assets to heirs. And perhaps a charitable lead trust can help.