Grantor Retained Annuity Trusts

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Individuals with taxable estates are always looking for efficient ways to plan for the eventual estate tax. One such planning technique is through a Grantor Retained Annuity Trust (GRAT).

A GRAT is a trust by which the person making the contribution (the “grantor”) makes a transfer of property to the trust and retains an annuity (equal to a fixed percentage of the value of the initial trust assets) for a specified term of years. At the end of the period, the remaining trust property transfers to the beneficiaries which the grantor designates in the trust instrument.

For gift tax purposes, the value of the gift by the grantor would equal the total value of the assets transferred to the GRAT less the present value of the grantor’s retained annuity payment for the period of time that the grantor designates.  The present value of an annuity is based on the amount of the annuity selected, the initial term selected, and the interest rate in effect for the month of the transfer (determined by the IRS.). The trust could be established to reduce the taxable gift to zero or close to zero (i.e., a “zeroed out” GRAT).  

The benefit of the GRAT is that if the investment return of the GRAT exceeds the interest rate used to determine the value of the grantor’s retained interest and the grantor survives the GRAT term, the investment return in excess of the interest rate will escape gift tax.  The August 2017 interest rate set by the IRS. is 2.4%. This interest rate is relatively low by historical standards and makes the current time a good time to utilize a zeroed out GRAT. Thus, the GRAT is particularly beneficial where the assets transferred to the GRAT have the potential to readily appreciate in value over the period of time selected.

However, a disadvantage of a GRAT is that if the grantor fails to outlive the term of the annuity, the remaining GRAT assets will be included in the grantor’s estate for estate tax purposes, thereby eliminating some or all of the potential estate planning benefits of the GRAT.

Another potential disadvantage of the GRAT is that it is more difficult to accomplish generation skipping transfer (“GST”) tax planning with GRATs.  This is so because the GST exemption cannot be allocated to the GRAT until after the initial term ends, when the value of the GRAT assets may substantially exceed the amount of the grantor’s remaining GST exemption.

If you are looking for creative and efficient ways to reduce your potential estate tax exposure, please do not hesitate to contact Morris Law Group to discuss if a GRAT is the right planning technique for you.


** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.

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