“Low interest rates and looming potential tax changes make this a good time for high-net-worth clients to use a special tool to transfer wealth: the grantor-retained annuity trust (GRAT), a strategy to reduce future estate taxes, by transferring assets to beneficiaries without using the lifetime gift tax exclusion.”
A Grantor-Retained Annuity Trust, or GRAT, is funded by the grantor, the person who creates the trust, in exchange for a stream of annuity payments at a predetermined interest rate—the IRS Section 7520 rate. The interest rate in December 2020 is 0.6%, as reported in the article “Transferring Wealth With This Trust Can Yield Big Tax Advantages” from Financial Advisor.
GRAT assets need only appreciate greater than the Section 7520 rate over the term of the trust, and any excess earnings will pass to beneficiaries, or to an ongoing trust for beneficiaries with no gift or estate tax.
Because the grantor takes back the amount equal to that which was transferred to the trust (often two or three years), which is set by the IRS when the trust is funded, future appreciation over and above the interest rate passes gift-tax free.
There’s little upkeep. Once the trust agreement is in place, a gift tax return needs to be filed once a year. If the trust is set up without a tax ID number, there’s no need to file an income tax return.
The grantor is responsible for the income generated by the asset in the GRAT, but that’s it. If the value of the property is increased following an audit, the gift won’t be increased but the annuity will. If the GRAT property decreases in value, the only out of pocket is the set-up costs.
Assets in a GRAT may be anything from an investment portfolio to shares in a closely held business.
Most GRATs are designed to have the value of the retained annuity be equal to the value of the property that is transferred to the GRAT. If the values are equal, then the amount of the gift for tax purposes is zero, since the value of the transfer less the annuity value is zero.
GRATs are not for everyone. The success of the GRAT depends upon the success of the underlying assets. If they don’t appreciate as expected, then there might not be a significant amount transferred out of the estate after paying for the legal, accounting and appraisal fees. If the grantor dies during the term of the GRAT before payments back to the grantor have ended, the GRAT will be unsuccessful.
Generation skipping transfers cannot utilize GRATS, since the generation skipping tax exemption may not be applied to a GRAT, until the grantor’s death.
Ask your estate planning attorney about whether a GRAT could benefit your family. If a GRAT is not a good fit, they will know about many other tools available.
Reference: Financial Advisor (Nov. 30, 2020) “Transferring Wealth With This Trust Can Yield Big Tax Advantages”