By William Lako
Expect rates to remain low for a while. The Federal Reserve said it would keep its benchmark interest rate near zero for as long as it takes until the economy starts to recover from the coronavirus crisis, indicating it may take several years. So, while the incentive to save is low, there are opportunities for consumers and investors with good credit.
A few weeks ago, I mentioned refinancing your mortgage because you can borrow 30-year money at historically low-interest rates. Refinancing a higher-rate loan is generally your best opportunity to save money. If you have the chance to increase your monthly cash flow by $200 or more, that could be the pay raise you’ve been looking for. Likewise, seniors may be able to withdraw less from retirement accounts.
As mentioned, savers may struggle to find yield. For certain situations, I recommend investors consider investing eight- to 10-year money in dividend-paying stocks to generate income. It can be a riskier move compared to staying with fixed-income investments, but you have to compare it to the risk of low interest rates. It has been a very long time since we’ve seen 5 % on a bond, but finding a high-quality, dividend-paying stock yielding 4% to 5% can be done.
Certain estate planning strategies can also benefit from a low interest rate environment. Families may consider a grantor retained annuity trust, a charitable lead annuity trust, an installment sale, or a low-interest loan.
A family may also consider placing a rapidly appreciating or high income-producing property in an irrevocable trust. You would then receive a fixed amount annually from the GRAT for a specified number of years. At the end of the term, any property remaining in the trust passes to the beneficiaries.
The value of the gift is discounted for tax purposes, and it removes a valuable asset from your estate. If the rate of appreciation is greater than the IRS interest rate, a higher value of trust assets escapes gift and estate taxation. Similar transfers can be done with charitable lead trusts if you’d rather a charity receive the fixed annual payments.
Installment sales or low-interest rate loans can also be used to remove assets from an estate. Generally, you’re required to charge an acceptable interest rate when loaning to family; otherwise, the interest you’re not charging could be considered a gift and may incur gift tax.
However, with the current low interest rates, you may be able to provide loans at a very low rate. The IRS applicable federal rate for a mid-term loan of three to nine years during September 2020 is 0.35 %. On a $1 million loan, the annual interest payment of around $3,500 could be forgiven as part of an annual exclusion gift, given the appropriate circumstances.
We tend to grumble about low-interest-rate environments because we’re trained to think as savers. However, the reality is that there are other beneficial moves investors can make to take advantage of low interest rates. Low interest rates are not a complete negative when it comes to financial planning.