What Are Grantor Retained Annuity Trusts (GRATs)?

For discerning individuals looking to safeguard their hard-earned wealth for future generations, estate planning becomes a crucial exercise. Among the numerous strategies, one emerging as a veritable favorite is the Grantor Retained Annuity Trust (GRAT). Touted as a deft maneuver to transfer wealth while minimizing tax implications, the GRAT is steadily gaining recognition among wealth managers and beneficiaries alike.

Fidelity, a leading wealth management firm, defines a GRAT as a distinctively designed trust allowing individuals and families to move wealth to future generations, barely denting their lifetime federal gift and estate tax exclusion. The IRS currently sets this exclusion amount at $12,920,000 for the year 2023.1,2

Creating a GRAT entails the formation of an irrevocable trust within a fixed timeframe. It involves placing assets in the trust and organizing a systematic annuity payout to the grantor each year. As the trust concludes, beneficiaries receive the remaining assets with minimal to zero gift tax liabilities.

Investopedia informs us that a GRAT allows the grantor to maintain the original value of the assets while gaining a return established by the IRS, known as the 7520 rate. This rate, at 4.40% as of March 2023, is employed to appraise certain charitable interests in trusts.3,4

Practically any asset class can be stowed into a GRAT. However, the strategy works best when the assets poised to appreciate over the annuity term are deposited into the trust. Stocks in burgeoning enterprises or pre-IPO companies, as well as prime real estate, make excellent candidates. The reason is simple: the beneficiaries receive the appreciation alone, which the IRS does not qualify as a gift, thereby ensuring it remains exempt from gift tax.

For instance, you place $1 million worth of stock in a GRAT for a four-year term. You receive an annuity payment of $250,000 each year, totaling to $1 million plus the annual interest at the 7520 rate. As the term concludes, your beneficiary receives the appreciated value of the asset over the four years, not subject to gift tax.

The principal advantage of a GRAT is the increased wealth that can be transferred to heirs, significantly circumventing gift tax, which can reach a steep 40%. ProPublica reports that over half of the 100 wealthiest American families employ GRATs to circumvent estate and gift taxes.5,6

In times of low-interest, GRATs can be particularly advantageous. Nevertheless, potential risks such as rising interest rates and market valuations, as well as changes in tax legislation, could dampen a GRAT’s effectiveness.

Your financial situation and long-term objectives will dictate whether a GRAT could be an effective instrument for your estate planning needs. Consultation with an experienced estate planning attorney can provide valuable insights and assess the feasibility of integrating a GRAT into your overall financial strategy.

Regardless of your chosen path, it’s clear that the deliberate stewardship of your wealth can ensure that your legacy endures for generations to come.