A goal of estate planning is to protect assets while minimizing taxation. For people who own income-producing assets, a Grantor Retained Annuity Trust, or GRAT can be an option for transferring wealth while still receiving income from those assets, and reducing taxes owed by their beneficiaries.
What is a GRAT?
A GRAT is an irrevocable trust which is created when the originator of the trust places their income-producing assets into a trust in exchange for a fixed payment, or annuity, from the trust. The trust can be created to exist for a finite number of years or the creator’s life. The term can be for as few as two years but may be more in some cases. Essentially a GRAT allows the grantor to keep their interest in the trust assets through their regular payments. However, to be a qualified interest, the GRAT annuity payment must be either a fixed dollar amount or a fixed percentage of the initial fair market value of the property. The annuity must also be paid at least annually. The rate of return on the annuity is prescribed by the IRS code and is commonly referred to as the “7520 rate”. When the annuity payment term is finished the assets of the trust will pass to its beneficiaries. There can be no additional funding of the GRAT trust once it is created.
What is the Main Advantage of a GRAT?
One of the most valuable parts of a GRAT is that when the trust ends, what is left can be distributed to named beneficiaries who will most likely not have to pay gift or estate taxes on these assets. In determining the beneficiaries’ tax liability, the law looks to the year the GRAT was created. The calculation is made by subtracting the fixed annuity’s value from the assets actual value. Whatever is left, is possibly subject to gift tax in the year the GRAT was created. With careful planning that amount left after this calculation can be very little or zero, resulting in no or low gift tax liability for the beneficiaries.
What is the risk of having a GRAT?
The main risk of a GRAT is that if the creator of the GRAT dies before the annuity term is completed, the assets in the GRAT become part of the creator’s estate which is subject to estate taxes. Therefore, it is essential to consider this risk of incurring taxes when using a GRAT.
A GRAT can be a valuable planning strategy which provides income and protects beneficiaries from taxation. To adequately prepare a GRAT it is vital that it be created with full knowledge of laws which govern them. Our office has experience navigating the complex rules and regulations which concerns GRATS and helping people determine if a GRAT is the right choice for their circumstances. Please contact us if we may be of assistance.