Grantor Retained Annuity Trust (GRAT)

Grantor Retained Annuity Trust (GRAT): A Grantor Retained Annuity Trust (GRAT) is an estate planning tool used to transfer assets to beneficiaries with minimal gift or estate tax consequences. Here’s a short overview:
  • Structure: A GRAT is an irrevocable trust where the grantor (the person creating the trust) transfers assets into the trust and retains the right to receive fixed annuity payments for a specified term (e.g. 2–10 yrs).
  • How it works:
    1. The grantor places assets (e.g., stocks, real estate, etc.) into the GRAT.
    2. The grantor receives annual annuity payments based on the initial value of the assets and a fixed interest rate (the IRS Section 7520 rate).
    3. At the end of the term, any remaining assets in the GRAT pass to the beneficiaries (e.g., children) tax-free.
  • Tax benefits:
    • The gift’s taxable value is reduced by the present value of the annuity payments the grantor retains, often resulting in a low or zero taxable gift (“zeroed-out GRAT”).
    • If the assets appreciate faster than the IRS 7520 rate, the excess growth passes to beneficiaries free of gift or estate taxes.
  • Risks and considerations:
    • If the grantor dies during the GRAT term, the trust assets are included in their estate, negating tax benefits.
    • Assets must outperform the 7520 rate for the GRAT to be effective.
    • Best suited for appreciating assets like stocks or real estate.
  • Use case: GRATs are popular for high-net-worth individuals looking to transfer wealth to the next generation while minimizing estate taxes, especially in low-interest-rate environments.

For example, if you transfer $1 million in assets to a GRAT with a 5-year term and a 2% 7520 rate, and the assets grow at 8% annually, the excess growth (above the annuity payments) passes to your heirs tax-free. For more details or specific calculations, consult a tax or estate planning professional, as GRATs involve complex IRS rules.