You may have heard some buzz recently about Grantor Retained Annuity Trusts (GRATs). As an estate planning strategy, GRATs work well in the current low interest-rate environment. They work especially well now that we have depressed values for certain asset classes. A likely reduction in the federal estate tax exemption amount in the near future further increases the immediate attractiveness of the GRAT.
GRATs are a special type of irrevocable trust where all, or a portion, of an asset is gifted into a trust with the Grantor retaining the right to receive an annuity payment. The person gifting the asset into the trust is called the ‘Grantor.’ The GRAT must require that the Grantor receive an annual annuity payment. Payments from the GRAT to the Grantor are scheduled over a set period of years. At the end of the set period, the annuity payments stop and the amount remaining in the GRAT is either distributed outright to the designated beneficiaries or retained in trust for their benefit, with the Grantor no longer having any interest in the GRAT.
For gift tax purposes, the value of the gift to the GRAT is reduced by the present value of the annuity payments. The present value is determined using an IRS established interest rate known as the 7520 rate. The annuity payments can be structured so the present value of the annuity payments equals the value of the asset gifted to the trust, reducing the gift tax value of the gift to zero. In that case, if the value of the assets in trust appreciate at a rate greater than the 7520 rate, then all appreciation in excess of that rate is transferred to the designated beneficiaries as a tax free gift that uses none of the Grantor’s federal estate tax exemption amount. With historically low 7520 rates and a potential for substantial growth in currently depressed assets, GRATS are particularly attractive now.