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What is the Section 7520 rate, and why does it matter?

The Wilson Group at Morgan Stanley Eric S. Wilson, CIMC®, Family Wealth Director

South Florida—Southeast Leading Wealth Advisor

The average person is enjoying many benefits in the current interest rate environment. People have been able to refinance their home, secure a new mortgage or take out a home equity line of credit at historically low rates.

For affluent individuals and families, however, there is more to the story. Current market conditions have impacted another interest rate: the Internal Revenue Code Section 7520 rate. Also known as the “discount” or “hurdle” rate, the Internal Revenue Code Section 7520 Rate is set each month by the IRS, and it is essential to the determination of the different prop-erty interests in split-interest trusts such as Grantor Retained Annuity Trusts (GRATs), Charitable Lead Trusts (CLTs), Charitable Remainder Trusts (CRTs) and Qualified Personal Residence Trusts (QPRTs).

In lay terms, the Section 7520 rate is the approved rate used by the IRS for discounting present values, annuities or future interests. Computationally, it is pegged monthly at 120 percent of the mid-term AFR rate and rounded to the nearest two-tenths of a percent. In both August and September, the 7520 rate was 1 percent.

Other leading wealth advisors have written articles for this magazine that detail the mechanics of the four trust types listed above, so I will spare you a repeat lesson. However, it may be help-ful to know which of the above trusts work well when the 7520 rate is high, and which work well when it is low, as it is now.

Let us begin with the QPRT. All other things being equal, the higher the 7520 rate, the higher the retained value of the grantor’s use of the prop-erty will be for the trust term, and, as a result, the lower the size of the gift. Therefore, in the current low-rate environment, it could be said that the time to set up a QPRT is not optimal if one is concerned with maximizing the leverage involved in setting up this type of trust. All other things being equal, a CRT also works better when the 7520 is high.

On the other hand, considering a GRAT and/or a CLT in the current low 7520 rate environment could, in fact, be optimal. Let us consider the GRAT first: If the grantor has assets that are expected to grow in an amount such that the earnings and growth combined will exceed the “hurdle” rate, all of the

appreciation in excess of this 7520 rate will be shifted to the remainder beneficiaries without any transfer tax cost. Therefore, the lower the 7520 rate, the better. Just to reiterate: The 7520 or “hurdle” rate for August and Sep-tember was 1 percent. Certainly, there are assets already in your portfolio that are projected to grow more than 1 percent over a two- or three-year period (a typical GRAT tenure), so why not consider this technique in the current environment?

A CLT also works better when the 7520 rate is low, all other things being equal. The lower the rate, the higher the gift or estate tax deduction is for the donor, thereby lowering the amount of the actual gift (assuming a non-grantor trust). Of course you need to be philanthropic to consider the CRT or CLT, but the majority of families I have worked with over the years would rather be philanthropic than just let the government tax and redistribute their wealth.

The Section 7520 rate is a very important interest rate for affluent families to become familiar with as they prepare to pass assets to the next generation.

By Eric S. Wilson

Eric S. Wilson is a Wealth Advisor with the Wealth Management division of Morgan Stanley in Macon, GA. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC. Morgan Stanley Financial Advisor(s) engaged Worth to feature this profile. Eric S. Wilson may only transact business in states where he is registered or excluded or exempted from registration: http://morganstanleyfa.com/ericwilson. Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Eric S Wilson is not registered or is excluded or exempt from registration. The strategies and/or investments referenced may not be suitable for all investors. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors or private wealth advisors do not provide tax or legal advice. This material was not intended nor written to be used, and it cannot be used, for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters.

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“The Section 7520 rate is a very important interest rate for affluent families to become familiar with as they prepare to pass assets to the next generation.”—Eric S. Wilson

Assets Under Management $1.6 trillion (Morgan Stanley Wealth Management)

Minimum Fee for Initial Meeting None required

Minimum Net Worth Requirement $5 million (planning services); $2 million in investable assets (investment services)

Largest Client Net Worth $25 million+

Financial Services Experience 18 years

Compensation Method Asset-based fees and commissions (investment and insurance products)

Primary Custodian for Investor AssetsMorgan Stanley Smith Barney LLC

Professional Services Provided Planning, investment advisory and money management services, advanced wealth transfer planning and liability management

Association Memberships IMCA, Fiduciary 360 (www.� 360.com)

Website Emailhttp://morganstanleyfa.com/ericwilson eric.s.wilson@morganstanley.com

The Wilson Group at Morgan Stanley 5444 Riverside Drive, 2nd Floor, Macon, GA 31210 478.471.2266 877.442.5445

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Eric S. Wilson is a wealth advisor and senior vice president at Morgan Stanley, and for the past 18 years he has served the varied needs of families whose wealth has the potential to change the essential nature of their descendants’ lives. Mr. Wilson began his career at Merrill Lynch in 1994, where he served until joining Morgan Stanley in 2010. For his work with affluent and high net worth families throughout the Southeastern United States, he has been specially designated at Morgan Stanley as a family wealth director. Achieving this prestigious designation meant adhering to stringent quantitative and qualitative requirements set forth by Morgan Stanley and now provides him with specialized and dedicated resources from around the firm, which benefits his clients by providing them with many of the same services offered by family offices. Mr. Wilson is a Certified Investment Management ConsultantSM (CIMC®) and an Accredited Investment Fiduciary Analyst (AIFA®). He proudly serves on the advisory boards of the Community Foundation of Central Georgia and Children’s Hospital of Central Georgia and is a member of the Macon Estate Planning Council. He and his wife, Cindy, are proud parents of four sons, ages 11, 11, 11 and 4.

About Eric S. Wilson

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Teaching my sons about life through sports, playing tennis, reading and gardening

MY HOBBIES ARE…

Freedom from Wealth, by Charles Lowenhaupt and Don Trone; Howard’s Gift, by Eric Sinoway; and The Explicit Gospel, by Matt Chandler

WHAT I ’M READING NOW…

A family that knows where it wants to go and is looking for

someone to help them steward the product of their life’s work.

WHAT MAKES A GOOD CLIENT…

How to reach Eric S. Wilson

Interested families may reach me with questions or with interest at 877.442.5445 or eric.s.wilson@morganstanley.com.

W O R T H . C O M D E C E M B E R - J A N U A R Y 2 0 1 3

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The Wilson Group at Morgan Stanley is featured in Worth® 2012 Leading Wealth Advisors™, a special section in every edition of Worth® magazine. All persons and firms appearing in this section have completed questionnaires, have been vetted by an advisory group following submission by Worth®, and thereafter paid the standard fees to Worth® to be featured in this section. The information contained herein is for informational purposes, and although the list of advisors presented in this section is drawn from sources believed to be reliable and independently reviewed, the accuracy or completeness of this information is not guaranteed. No person or firm listed in this section should be construed as an endorsement by Worth®, and Worth® will not be responsible for the performance, acts or omissions of any such advisor. It should not be assumed that the past performance of any advisors featured in this special section will equal or be an indicator of future performance. Worth®, a Sandow Media publication, is a financial publisher and does not recommend or endorse investment, legal or tax advisors, investment strategies or particular investments. Those seeking specific investment advice should consider a qualified and licensed investment professional. Worth® is a registered trademarkof Sandow Media LLC. See “About Us” for additional program details at http://www.worth.com/index.php/about-worth.

Eric S. Wilson, AIFA®, CIMC® Family Wealth Director

The Wilson Group at Morgan Stanley5444 Riverside Drive, 2nd Floor

Macon, GA 31210Tel. 877.442.5445

eric.s.wilson@morganstanley.comhttp://morganstanleyfa.com/ericwilson