Before becoming a comedian, Jeffrey Jena worked as a grade-school teacher. “Children are stupid,” he says. “That’s why they’re in school. I’d lecture for an hour about percentages and interest rates, and at the end I’d ask one simple question: You put ten grand in the bank for one year at five and a half percent, and what do you get? Some kid would always yell out, ‘A toaster.'”
With money market, CD, and savings account interest rates at all-time lows, the toaster sounds good these days. However, low interest rates do create planning opportunities.
Pensions
If you have a defined benefit plan (better-known as a pension), a low-interest-rate environment can improve your lump-sum pension payout. If you are eligible for a pension, now is a good time to consider a lump-sum payout because your employer or former employer will offer a larger lump sum than when interest rates are higher.
Here’s why. When you have a pension, often you have the option to take your pension in a one-time, lump-sum payout or as a guaranteed lifetime monthly payout. To calculate the lump-sum pension benefit, companies use a standard interest rate, a mortality table, and your years of service. The amount of the lump sum, invested at the standard interest rate, is supposed to equal the amount you would have received in annuity payments over your expected lifetime. The interest rate that companies use is now typically based on high-quality corporate bond rates. Since these rates are low, a larger lump sum would be needed to give you that monthly payment.
Applicable Federal Rates
Every month, the IRS publishes the Applicable Funds Rates (AFR). When interest rates are low, the AFR is low—and that’s potentially good for you.
- Intra-Family Loan. Clients occasionally want to make a loan to a family member to help him or her purchase a house, buy a car, pay off high-interest debt, or start a business. The IRS generally treats an interest-free loan (or any loan below market interest rates) as a gift, which makes the loans subject to gift tax rules. The AFR determines the interest rate that will avoid gift status. In September 2010, the AFR for a mid-term (3- to 9-year) loan was 1.94%. Therefore, you can loan family members money and charge them interest as low as 1.94%, without the loan being deemed a gift.
- GRAT and CLAT. A Grantor Retained Annuity Trust (GRAT) or a Charitable Lead Annuity Trust (CLAT) allow you to transfer wealth to family members and charities during your lifetime without paying large taxes. Because these also are based on the AFR, low interest rates provide a greater opportunity to transfer additional assets to your heirs and to charities.
Student Loans
With mortgage, home equity, and home equity line of credit (HELOC) loans at low interest rates, it is possible to use these loans to pay off student loans. However, you should talk with your advisor about the tax implications of using a HELOC, as well as the matter of using your house as collateral for a loan.
My grandmother actually told me, “When life gives you a lemon, make lemonade.” Low interest rates are lemons in terms of your investments, but with a little work, you can make lemonade.
If you have questions or comments or would like assistance using one of these techniques, please contact me at mstinson@bwfa.com or 410-461-3900.