CTC_Social Graphic_Depressed Assets

By Jeff Cowley, J.D., CEPA, AEP® – Executive Vice President & St. Louis Market Executive

Depressed asset values are often a source of frustration and worry for investors. However, with those concerns often come opportunities to achieve long-term planning objectives. The adage of “never let a crisis go to waste” comes to mind. If an investor can still meet their liquidity needs and maintain sufficient capital reserves, a depressed asset environment often presents powerful planning opportunities.

Roth Conversions

Converting a Traditional IRA to a Roth IRA is often a valuable tool to help account owners take advantage of current versus future income tax rates and long-term appreciation potential. At the time of conversion, the account owner must pay income tax on the amount that is converted. If that income tax rate is currently less than what it may likely be at the time of retirement, then it can be a beneficial income tax reduction strategy. Given depressed market values, this same scheme could be employed at a potentially much greater savings – less tax would be due on the same conversion.

While Traditional IRAs require owners to take Minimum Required Distributions, Roth IRAs do not. For an account owner who does not need the income in retirement, converting to a Roth could be a beneficial strategy to consider. If income tax is a concern at the time of conversion, then charitable deductions could help in minimizing that tax burden.

Promissory Notes

Intra-family loans are a good way to transfer wealth to future generations without triggering any estate or gift tax considerations. These loans can be used for immediate liquidity purposes or for long-term, larger acquisitions. The interest rate for intra-family loans is based on the Applicable Federal Rate (AFR) and is currently around five percent. Additionally, the lender can later choose to forgive interest payments or the principal balance, which may qualify for the annual gift tax exclusion.

Gifting of Discounted Assets

If reduction of an owner’s taxable estate is of concern, depressed asset values could present optimal opportunities for gifting. Lower valuations may allow for more assets, as the price recovers, to be gifted to family members. However, other factors like income tax should be considered. The donee will keep the donor’s basis in the asset. Other concerns, such as whether to gift outright or in trust, should also be weighed.

Exercising Stock Options

Ordinary income tax is paid when an employee exercises stock options. The amount of tax is determined by the difference in the grant price and the fair market value when exercised. If those values are temporarily depressed, it may make sense to exercise the options now, triggering a reduced tax liability for the taxpayer.

Swapping Grantor Trust Assets

Many irrevocable trusts give the grantor “the power of substitution.” This power allows the grantor to substitute assets from the trust for different assets of a similar value. While the power is included for specific income tax reasons, it can also serve as a valuable way to capture future asset appreciation and shield it from future estate tax inclusion. Swapping fixed income securities for aggressive growth equities would be an example of this concept. If the value of the equities were temporarily depressed, the grantor would be able to transfer more shares for a similar value.

Funding GRATS

A Grantor Retained Annuity Trust (GRAT) is a statutory mechanism designed to shift an asset’s future appreciation to the grantor’s family while using little to no gift tax exclusion. In this strategy, the grantor transfers assets to an irrevocable trust and receives an annuity payment back for a specified term of years. At the end of the GRAT term, the assets pass to the beneficiaries, either in trust or outright.

To be successful, the assets inside the GRAT must grow at a rate greater than the applicable IRS 7520 rate used in creating the GRAT. In the current market environment, those assets can be significantly discounted shares of publicly traded stock. Selling assets to an Intentionally Defective Grantor Trust (IDGT) is a similar maneuver which can yield significant value for the grantor’s family.

Regardless of the mechanism used, leveraging the depressed value of certain assets can be a beneficial way to complete or further legacy gifts. In addition to these advanced planning concepts, this is also a good time to review other estate planning documents to ensure that the included provisions still align with intentions and desires.