A Grantor Retained Annuity Trust (GRAT) is when a grantor wants to transfer the appreciation of an asset to an heir(s) while also reducing the value of the asset that might be subject to estate or gift taxes. It is generally used by individuals as a possible tax shelter for a high-value asset(s) they want to pass to a beneficiary.
How to Set Up a GRAT
To set up a GRAT, a trust maker puts an asset into an irrevocable trust. The value of the asset is locked in the trust over a fixed-term—usually two to 10 years. At the end of the term, the trust is closed. If the grantor is still living, the trust pays the asset and any appreciation to the beneficiary.
During the trust term the grantor can receive a yearly payment. The payment is in the form of an annuity. It equals a percentage of the value of the asset when it was locked into the trust plus the annual interest rate set in the IRS’s assumed rate of return set in its section 7520. In 2022, the 7520 rate went from a low of 1.6% in January to a high of 5.2% in December. This type of annuity differs from an insurance-based annuity as it is paid by the trust.
At the end of the trust, if the grantor is still living, the beneficiary inherits the remaining value of the asset after the final annuity is paid plus any appreciation. If the trust maker dies before the end of the term, the trust returns the asset to the taxable estate.
Some GRATS are set up as a zeroed-out trust. The annuity payments are calculated to add up to the value of the asset when it is placed in the trust. If the asset appreciates, the beneficiary receives the gift of any appreciation above the IRS’s interest rate, potentially without tax liability. If the asset is left in the grantor’s estate, it would be subject to the current estate tax when they die.
For example, say an asset is worth $15 million when placed in a 10-year trust and is expected to have an appreciation of $10 million. If the annuity payments over 10 years equal the original $15 million value, the heir stands to inherit the portion of the $10 million. Any amount above the IRS’s current tax rate is potentially tax-free.
A GRAT is sometimes useful with assets that have high growth potential or are high-income producing. However, because it is a complex part of estate planning, consulting with a qualified estate planner or attorney is imperative.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Hypothetical examples shown are for illustrative purposes only.
