~~The Federal Reserve Bank increased interest rates back in December and almost everyone thought interest rates would start to rise. The IRS issues applicable federal rates (AFR) each month that indicates the minimum amount of interest that should be charged on loans and other related transactions.
For February, the long-term rate (loans longer than 9 years) was 2.62%. These rates usually change about 10 basis points plus or minus each month. The month of March rates were just released and the rate dropped from 2.62% to 2.31%. This is a large drop in rates for one month. The mid-term rate (3 to 9 years) is now at 1.47% down from 1.82%.
Taking advantage of low rates is a great way to reduce potential estate or gift tax burdens. Loaning money to your children at low rates for an investment that returns high rates results in potentially a lot of wealth being transferred to the next generation with no estate or gift tax owed. Let's look at a quick example:
Assume a farm family has an option to invest in a non-farm business that may show a 15% compounded rate of return over a 10 year period. The investment is $1 million. Instead of mom and dad investing, they loan the $1 million to their kids and charge 2.31% interest on the loan (interest only). At the end of 10 years, the investment is now worth about $3.6 million and the kids pay back mom and dad the million dollar loan. The effectively transfers about $2.6 million of wealth over to the children (or grandchildren) free of estate or gift tax.
As you can see, there are many ways to reduce your estate or gift tax burden. Above is just one example. There are many others and we will share those in the months ahead.