One advanced estate planning option, especially for those looking for a regular income, is a GRAT or “Grantor Retained Annuity Trust.” Depending on your goals, these trusts can be an excellent planning tool, even for those without a federally taxable estate.
First, a basic definition: a Grantor Retained Annuity Trust is created by a “grantor” who transfers assets to the GRAT for a specific period of time. A recent article in AccountingWeb, “The Beauty of Grantor Retained Annuity Trusts,” notes that the GRAT, which often contains stock or closely-held business interests, typically holds assets for a specific period of time. While it’s usually between five and ten years, a GRAT could also be set up for a shorter time period, such as two years.
The language of a GRAT is often written to provide that the grantor retains the right to receive back, in the form of annual fixed payments (an annuity), 100% of the initial fair market value of the assets transferred to the GRAT. The grantor also receives a rate of return on those assets based on the IRS-prescribed interest rate, called the “7520 rate,” after the Internal Revenue Code Section 7520. Section 7520 specifies the way in which this rate is to be calculated. For example, the IRS’s 7520 rate for February 2017 is 2.6%.
One helpful feature of a GRAT is that any asset remaining in the trust at the end of the term passes to the named beneficiaries—often the grantor’s children—without any additional gift tax. This type of GRAT is often called a “zeroed-out GRAT” because it doesn’t end up with the grantor making a taxable gift. That’s due to the retention of an annuity equal to 100% of the assets contributed to the GRAT.
To give an example, if stock of a family business valued at $500,000 were placed into a GRAT for a term of ten years, and the 7520 rate were 1.6%, you would pay the grantor $50,000 a year, plus 1.6% in interest. It’s important to note that if you put the stock of an S corporation into a GRAT, you’d be required to refile the S-election under the QSub rules.)
A GRAT freezes assets, so after the GRAT has zeroed out in ten years, the appreciated value remains in the GRAT and passes to the beneficiaries, gift-tax free. However, there is a risk associated with the GRAT you should factor into your decision to use it: if the grantor dies during the term of the GRAT, the assets stay in the grantor’s taxable estate and the amount does not avoid gift taxes.
This simply means you need to make an informed decision about whether or not a GRAT is appropriate for your estate. An experienced estate planning attorney familiar with GRATs can help you determine if it’s the right estate planning tool for you.
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Reference: AccountingWeb (November 18, 2016) “The Beauty of Grantor Retained Annuity Trusts”