Throughout 2022 to-date, the Federal Reserve has raised interest rates in its effort to tame inflation and they’re not done yet. For advisors leading estate and charitable planning for high-net-worth clients, IRS-provided interest rates are a key factor in determining the benefits for clients as they consider alternative strategies.
Relatively speaking, rates related to charitable giving – like the Section 7520 rate which impacts the various tools of charitable giving – are still historically low but they’re rising fast. This provides an opportunity for financial advisors to reassess clients’ philanthropic initiatives – perhaps, discussing with them alternative approaches that better meet their goals in a rising rate environment.
To help bring it to life for financial advisors, I recently interviewed Russell A. Willis III, J.D., LL.M with the planned giving risk management consultancy, Charitable Solutions, LLC, on the §7520 rate and charitable giving Here’s what Russ had to say.
First, for those who don’t know, Internal Revenue Code §7520 is used to value charitable interests in trusts, like figuring the present value of an annuity or a remainder interest in any kind of planned gift. The §7520 rate is 120% of the applicable federal midterm rate (AFR). The §7520 rate has gone from 1.6% in January to 3.6% in July 2022.
Two types of charitable trusts that are impacted are Charitable Remainder Annuity Trusts (CRATs) and Charitable Lead Annuity Trust (CLATs). These are both “split income strategies” where the present beneficiary of an asset differs from the remainder beneficiary. The §7520 rate rise has had an especially strong effect with respect to annuities. For advisors, it’s important to know how CRATs and CLATs are impacted differently by the rate increase.
With a CLAT, the annuity payments are made to the charity and, when the donor dies or based on a specified term, the non-charitable beneficiaries get the remaining assets in the trust. The value of the remainder is equal to the value of the property less the value of the charity’s annuity. As the §7520 rate rises, the value of the annuity goes down. So, a larger annuity is needed to generate a gift, and less property can be transferred to the non-charitable recipients when interest rates are high. The advisor must use either a higher payment to charity or a longer trust term to achieve the same results as they would have when rates were lower
For donors, CRATs are better when interest rates rise. With a CRAT, the grantor places an asset in a charitable trust. The trust pays a fixed annuity to the grantor for a term of years or for life. At the end of the annuity term, the remainder is given to a designated charity. The value of the remainder, calculated using the §7520 Rate at the time the trust is created, gives the grantor an income tax charitable deduction. The higher the §7520 Rate, the higher the value of the charitable interest and the larger the income tax deduction.
What’s most important is for advisors to maintain good situational awareness. You need to be in tune with what's going on around you before you ever contemplate suggesting or modeling a gift for any individual client. As inflation kicks in, the wealthy tend to be much more fearful about parting with assets or making gifts. While inflation and rising rates can often negatively impact charities, they don’t have to deter donors from philanthropy with the right plan from an informed advisor.