A grantor-retained annuity trust (GRAT) is an estate planning tool that can be used to save on estate and gift taxes when transitioning business and farm assets to the next generation. These irrevocable trusts are particularly beneficial in transferring assets that are expected to appreciate in value.

The person who creates the trust is called the grantor. The grantor transfers ownership and control of the assets to the trust. Though the grantor does not own the assets any longer, the trust is designed so the grantor is responsible for paying the taxes on the income earned by the trust.

The trust will make annual payments to the grantor. The payments that are made to the grantor are not taxable. The grantor will decide on the number of years these payments will be made. The amount of the annual payments is calculated based on multiple factors including the IRS Section 7520 rate. The IRS publishes the Section 7520 rate each month. Generally, the lower the interest rates, the lower the IRS Section 7520 rate. It is better to have a lower annuity amount paid to the grantor, because this means more assets will be transferred to the beneficiaries. Generally, cash will be used to make the annuity payment; but if that is not possible, stocks, bonds or business interest can be used.

Terms of GRATs

The trust term must be at least two years, but there is not a maximum length. Consideration should be given in setting the term, because if the grantor dies before the term is up, the assets held in the trust revert back to the grantor and are included in their taxable estate. This risk can be alleviated by stacking multiple GRATs over a period of years. These are called rolling GRATs. Each GRAT term would be for the minimum term of two years. This way, at least part of the gift would be completed, so long as the grantor survived the two-year term period.

After the term of the trust is over, the assets are transferred to the beneficiary. Any gift or estate tax due is calculated by subtracting the value of the grantor’s annuity interest from the value of the asset given to the trust.

This trust plan is great for a person who has assets that are expected to appreciate in value and wants to transfer the assets to their children, but also wants to keep an income stream from the assets for a period of time.

Balzarini is an attorney at law with Miller Legal Strategic Planning Centers, a Division of Hellmuth & Johnson. Contact him at [email protected].