Another advanced estate planning technique is known as a grantor retained annuity trust (a “GRAT”). GRATs are created by transferring one or more high yield assets into an irrevocable trust and retaining the right to an annuity interest for a fixed term of years or for the shorter of a fixed term or life. When the retention period ends, assets in the trust (including all appreciation) go to the named “remainder” beneficiary. In some cases other interests, such as the right to have the assets revert back to the transferor’s estate in the event of the transferor’s premature death, may also be included.
GRATs provide a fixed annuity payment, usually based on a fixed percentage of the original value of the assets transferred in trust. For example, if $500,000 is placed in trust and the initial annuity payout rate is 6%, the trust would pay $30,000 per year, regardless of the value of the trust assets in subsequent years. If income earned on trust assets is insufficient to cover the annuity amount, the payments will be made from principal. Therefore, the transferor is assured of steady consistent payments throughout the term of the GRAT. At the same time, all income and appreciation in excess of that required to pay the income beneficiary is accumulated for the benefit of the remainder beneficiary free of gift tax and without using the transferor’s lifetime gift tax exemption.
The gift tax value of the transferred assets is determined at the time the trust is created and funded by subtracting the value of the annuity interest from the fair market value of the assets transferred to the trust. The annuity interest is generally valued based on the 7520 rate published by the IRS. Therefore, if the return on the GRAT assets over the term of the GRAT is greater than the 7520 rate, it may be possible to transfer assets to the remainder beneficiary when the trust terminates that far exceed the gift tax value of the transferred assets.
The one drawback of a GRAT is that GRAT assets will be included in the transferor’s estate if he/she passes away during the term of the GRAT. Therefore, the GRAT is a bet to live strategy – the transferor is betting that he/she will survive the term of the GRAT to reap its estate and gift tax benefits.
There may be other non-tax reasons to form a GRAT as well. A GRAT can help you ensure succession. For example, if a client wants specific assets, such as stock in a closely held corporation, other business interest, land, or family compound to go to one child rather than another, or the client does not want a former spouse, creditor, or someone who contests his/her Will to be able to obtain that asset, a GRAT can be used to implement such a contingency.
For more information regarding estate planning, business law or tax controversy and compliance, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com or call us at 404-255-7400.
In accordance with IRS Circular 230, this article is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purpose. The information contained herein is provided “as is” for general guidance on matters of interest only. Hoffman & Associates, Attorneys-at-Law, LLC is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. Before making any decision or taking any action, you should consult a competent professional advisor.