It is a world of harsh realities for reps. Interest rates are at historic lows; stocks, while showing signs of life, are still radioactive to many clients. Yet competition for high-net-worth investors is at an all-time high. Client referrals? Those seem to be drying up too.
But despair not. The first two factors may help savvy financial advisors to solve the problem of the latter two issues. One way to liven your practice up is to get acquainted with grantor-retained annuity trusts (GRATs). GRATs are legal instruments designed to allow individuals to pass large sums of money to future generations, with substantially lower gift or estate taxes than would otherwise be paid. Here's how they work: The client places an asset in a trust with a predetermined expiration date and then names his heirs as the remainder beneficiaries of the trust (meaning they get whatever is left when the trust ends). The client withdraws a fixed-dollar amount annually. And, as with an annuity, the amount withdrawn is equal to the principal plus interest (at a rate determined by the IRS's Section 7250) amortized over the life of the trust.
The crucial factor is the Section 7250 rate — the interest rate the government uses to make this kosher (details are available at irs.gov). Right now, the rate, which can fluctuate monthly, sits at about 3.8 percent — near all all-time lows. This is significant because the lower the ratio of Applicable Federal Rate (AFR) relative to the payout, the lower the value of the remainder gift. This can result in reducing or even eliminating gift taxes when the asset transfers into a trust. If the asset earns more than the percentage the grantor takes out, the extra money stays in the trust and upon termination passes to the beneficiaries free from gift and estate taxes.
What can go wrong? Not much. If the client expires before the trust does, the whole thing goes back into his estate, and the heirs are no worse off than if nothing had been done to start with (aside from the cost of establishing the trust.)
The assets in the trust could also earn less than the percentage rate the grantor is taking out, possibly rendering the whole exercise meaningless. That is why assets with more predictable price appreciation are the best choices for a GRAT.
Whom to Contact
Investors with portfolios in the middle seven figures would obviously qualify. But some other groups of current and potential clients also need to hear about GRATs:
Founders of successful closely held enterprises are especially good candidates for GRATs. They qualify for all the benefits listed above — and more. Because of liquidity issues, the IRS may allow substantial valuation discount in shares of the business put into the trust — sometimes as much as 50 percent.
Real estate owners
The recent rise in property values has turned former farmers into newly minted millionaires. Buildings and dirt can be put into a GRAT as well, as long as they kick off enough annual income to satisfy the Section 7250 requirements.
Only financial advisors with a “JD” after their names can advise clients on the particulars of establishing a GRAT. However, that restriction does not lock others out. Advisors can find an attorney qualified to do this type of work and establish a mutually-beneficial referral relationship.
If a targeted HNW client cherishes a particular benevolent organization, he or she can still reap GRAT-like benefits. By using a charitable lead annuity trust (CLAT), the annual income from the trust will go to the charity. The client (or someone of his choosing) will receive the remaining interest, and if the CLAT is designated as a grantor trust, the client pockets the tax benefit of the original donation.
Using this strategy to boost your business is not just good for the client side of your practice. You can team up with an estate planning attorney to explain the benefits of a CLAT in a seminar to the “friends” of the charity in question, thereby positioning yourself as an expert in front of several pre-qualified, HNW prospects.
But the time to talk to people about GRATs and CLATs is now. Soon interest rates might rise, stock prices might jump, and advisors will look back on these days with fond remembrance.
Writer's BIO: Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future. kevinmckinley.com