Grantor Retained Annuity Trust (GRAT): Transferring Appreciating Assets With Tax Efficiency

Gabriel Katzner - July 5, 2024 - Estate Planning
Grantor Retained Annuity Trust (GRAT): Transferring Appreciating Assets With Tax Efficiency

Grantor retained annuity trusts (GRATs) are irrevocable trusts that grantors can use to place assets that are expected to increase significantly in value and distribute them to beneficiaries while limiting their estate and gift taxes.

What is a Grantor Retained Annuity Trust (GRAT)?

A GRAT is one of many options available in estate planning to minimize taxes while making large financial gifts to family members.

  1. The grantor or individual establishing the trust creates an irrevocable trust for a limited period of time.
  2. The grantor transfers property, assets, and investments that are expected to appreciate significantly to the trust, such as high-yield or growth stocks, shares in startup companies, and interest in businesses or real estate.
  3. The value of the trust is split into the annuity stream and the remainder interest.
  4. The grantor receives an annuity that is paid out yearly. The annuity payments to the grantor are calculated using the Internal Revenue Service (IRS) Section 7250 interest rate, commonly referred to as the hurdle rate.
  5. The grantor retains the right to receive the original value of the assets over the lifetime of the GRAT while earning the interest rate.
  6. When the trust expires, the assets are distributed to the beneficiaries. The beneficiaries receive the appreciation value of the assets minus the interest rate and the annuity payments.
  7. The grantor may structure annual payouts over the lifetime of the trust to equal the initial investment. This way, the final payout to the beneficiaries is zero and does not incur any taxes. It does not use any of the grantor’s lifetime combined exemption.

Ideally, the GRAT assets will appreciate more than the hurdle rate. When this happens, the grantor experiences significant estate-tax savings, and increased wealth is transferred to the beneficiaries.

The grantor pays transfer taxes on the fair market value of the property, minus the value of the grantor’s retained annuity interest. All income, gains, losses, and credits are taxed to the grantor. The trust assets are not reduced by paying taxes.

If the GRAT assets fail to outperform the Section 7520 rate, the assets are returned to the grantor, as the trustee will use the principal to pay the annuities. The grantor will have paid little to no gift taxes and would only be out the cost of establishing and administering the trust.

If the grantor dies before the GRAT expires, trust assets are returned to the grantor’s estate and, therefore, incur estate taxes. Grantors may choose to use rolling GRATs to decrease the risk of not outliving their GRAT. Multiple GRATs are established, with the annuity payments from one GRAT funding the next one. If the grantor dies, only the currently active GRAT would revert to the estate.

What term length is best for a GRAT?

Common GRAT terms extend from two to ten years. If you choose a longer term, it allows for more time for your assets to appreciate and locks in the hurdle rate for a longer period. Of course, the rate at which your assets appreciate depends on market conditions, but if you choose a longer term and the assets appreciate as you anticipate, the higher the remaining balance you will be able to pass to your beneficiaries without incurring gift or estate taxes.

What are the benefits associated with a GRAT?

If you have assets expected to appreciate in the next 5 to 10 years, you can transfer those assets to a GRAT, where they can appreciate separately from your estate. This allows you to pass on the appreciation value to your beneficiaries without incurring estate (up to 40%) or gift taxes. The IRS hurdle rate is an interest rate that changes monthly. The lower the rate, the less your assets need to appreciate to pass value to your beneficiaries.

What are the potential risks associated with a GRAT?

It is essential to discuss the risks and benefits of a GRAT with your estate attorney to verify whether it is the best estate planning tool to meet your needs. Potential risks or drawbacks with a GRAT include:

  • Tax laws may change, limiting GRAT benefits and changing the estate tax exemption.
  • GRATs work best when the section 7520 interest rates are low.
  • If the trust assets do not generate enough income, the trustee must pay the annuity with the trust’s principal.

GRATs are irrevocable trusts, so the trust agreement terms cannot be changed after the trust is established. Seek expert guidance before establishing a GRAT or other trust to ensure that it does not trigger unintended consequences.

To determine whether a GRAT would meet your estate planning needs, schedule a call with us at 855.631.3457 to learn more about how to protect those most important to you.

 

Gabriel Katzner

In 2002, Gabriel Katzner, the founding partner of Katzner Law Group received his Juris Doctorate with honors from the Fordham University School of Law. After spending the first 7 years of his legal career
practicing at Cahill Gordon & Reindel LLP, an international law firm based in New York, he went on to found his own firm.

Gabriel Katzner has a track record, along with a vast number of
outstanding public reviews across platforms, of working hard on behalf of individuals who need assistance with comprehensive
estate planning services. Finding a lawyer who is knowledgeable about revocable and irrevocable trust planning, guardianship for minor children, asset protection, trust administration and probate,
as well as Medi-Cal / Medicaid planning is extremely important.

Years of experience: More than 17 years
Location: San Diego, CA



#

This page has been written, edited, and reviewed by a team of legal writers following our comprehensive editorial guidelines. Furthermore, it has received approval from attorney Gabriel Katzner, an experienced estate planning lawyer with over 17 years of legal expertise.

Online Appointment Request

Schedule Consultation  

or

Call Our Office

  (855) 528-9637