Wealth Management Update (August 2014)

August Interest Rates for GRATs, Sales to Defective Grantor Trusts, Intra-Family Loans and Split Interest Charitable Trusts The August § 7520 rate for use with estate planning techniques such as CRTs, CLTs, QPRTs and GRATs is 2.2%, the same as the § 7520 rate for July. The August applicable federal rate ("AFR") for use with a sale to a defective grantor trust, self-canceling installment note ("SCIN") or intra-family loan with a note having a duration of 3-9 years (the mid-term rate, compounded annually) is 1.89%, up 0.07% from July.

Lower rates work best with GRATs, CLTs, sales to defective grantor trusts, private annuities, SCINs and intra-family loans. The low AFR presents a potentially rewarding opportunity to fund GRATs in August. Current legislative proposals would significantly curtail short-term and zeroed-out GRATs. Therefore, GRATs should be funded immediately in order to be grandfathered from the effective date of any new legislation that may be enacted.

Clients also should continue to consider "refinancing" existing intra-family loans. The AFRs (based on annual compounding) used in connection with intra-family loans are 0.36% for loans with a term of 3 years or less, 1.89% for loans with a term between 3 and 9 years, and 3.09% for loans with a term of longer than 9 years.

Thus, for example, if a 9-year loan is made to a child, and the child can invest the funds and obtain a return in excess of 1.89%, the child will be able to keep any returns over 1.82%. These same rates are used in connection with sales to defective grantor trusts.

Inherited IRAs are not exempt from creditors In Clark v. Ramekers, 573 U.S. (June 12, 2014) the United States Supreme Court addressed the issue of whether funds held in an inherited IRA are exempt from bankruptcy creditors under 11 U.S.C. § 522(b)(3)(C), ultimately holding that such funds are not exempt because they do not constitute "retirement funds" within the meaning of § 522(b)(3)(C).

At issue in Clark was an inherited IRA owned by Heidi Heffron-Clark ("Heidi"). Heidi had inherited the IRA from her mother upon her mother's death. Several years after inheriting the IRA, Heidi filed for bankruptcy and claimed that the funds within the inherited IRA were exempt from the claims of her creditors under § 522(b)(3)(C).

Section 522(b)(3)(C) exempts from the claims of bankruptcy creditors "retirement funds" that are held in an account or fund that is exempt from taxation under IRC §§ 401, 403, 408, 408A, 414, 457 or 501(a). Accordingly, to qualify for the § 522(b)(3)(C) exemption, two requirements must be satisfied:

(1) The funds must be held in a qualifying tax-exempt account or fund and

(2) The funds must constitute "retirement funds."

Inherited IRAs are exempt from taxation under IRC § 408, therefore satisfying the first requirement of § 522(b)(3)(C). The only issue left for the Court to determine was whether the funds held in the inherited IRA constituted "retirement funds" with respect to Heidi. Because the term "retirement funds" is not defined in the bankruptcy statutes, the Court applied the ordinary meaning of the term. According to the Court, the ordinary meaning of "retirement funds" is "a sum of money set aside for the date an individual stops working." Applying this definition of "retirement funds" in reaching its conclusion that funds held in an inherited IRA do not constitute "retirement funds" for purposes of the § 522(b)(3)(C) exemption, the Court identified the following three legal characteristics of inherited IRAs which distinguish inherited IRAs from traditional or Roth IRAs:

(1) The holder of an inherited IRA is prohibited from making additional contributions to...