What is a Grantor Retained Annuity Trust (GRAT)?
A grantor-retained annuity trust (GRAT) is a financial tool for estate planning to reduce taxes on substantial contributions to family members. These arrangements form an irreversible trust for a specific duration. The trust holds assets and pays an annual annuity to the donor. At the end of the trust and the last annuity payment, the beneficiary receives the assets with minimal or no gift taxes.
Understanding
Grantor Retained Annuity Trust (GRAT)
Grantor-retained annuity trusts are irrevocable gifts that enable a grantor or trust maker to transfer large amounts of wealth to the next generation with minimal or no gift tax burden. GRATs last a specific time.
A grantor creates a GRAT by contributing assets to the trust, retaining the right to receive the original value while receiving a preset IRS rate of return (known as the 7520 rate) throughout the agreement duration. After the GRAT’s duration, the grantor’s beneficiaries get any remaining assets (the original assets’ appreciation less the IRS-assumed return rate).
Grantor Retained Annuity Trust (GRAT) Risks
A GRAT pays annuity payments from trust asset interest or a portion of asset value. If the trust creator dies before the trust expires, the assets become part of their taxable estate, leaving the beneficiary with nothing, rendering the GRAT ineffective.
A successful GRAT presupposes asset appreciation; thus, if assets depreciate, it fails. Risk: The IRS’s 7520 rate has been so low over the last decade that it reduces the final benefit of adopting a GRAT.
GRAT Uses
Wealthy people with significant estate tax liabilities benefit most from GRATs. A GRAT might freeze their estate’s worth by transferring appreciation to their heirs. If an item was worth $10 million but was anticipated to increase to $12 million in two years, a person may pass the difference to their children tax-free.
The grantor’s estate includes the remaining interest if they die during the GRAT. However, the grantor can grant their surviving spouse the right to receive any leftover annuity payments to qualify for the estate tax marital deduction and minimize GRAT asset estate tax liability.1
GRATs are popular with startup shareholders since IPO stock price growth frequently exceeds the IRS expected rate of return. That allows the grantor to leave more money to children without reducing their estate and gift tax exemption.
GRAT History
GRATs gained popularity in 2000 after a favorable U.S. Tax Court case involving Walmart Inc.’s Walton family. In Audrey J. Walton v. Commissioner of Internal Revenue, the court favored Walton’s use of two GRATs, establishing annuity payments to return all original assets to the grantor and leaving only the appreciated value to beneficiaries.
This set-up reduces the gift’s value to zero and transfers any residual value to the beneficiary tax-free. This is a “zeroed-out GRAT” or “Walton GRAT.”
Example of GRAT
Before its IPO, Mark Zuckerberg invested Facebook’s equity in a GRAT. Forbes magazine valued Zuckerberg’s stock at $37,315,513, which is outstanding.
Conclusion
- Grantor-retained annuity trusts (GRATs) are estate planning tools that lock assets in a trust that pays yearly income.
- After death, the recipient obtains the assets with little or no gift tax.
- GRATs help affluent people reduce taxes.
