In these uncertain times, as Congress debates sweeping tax reforms, you might consider taking advantage of a proven method for transferring wealth to future generations: a grantor retained annuity trust, or GRAT. This estate planning technique can be particularly helpful while interest rates remain relatively low. And, depending on how your GRAT is constructed, the grantor—the person funding the trust—may be able to transfer assets to beneficiaries with little or no estate or gift tax consequences.
With a GRAT, the grantor first transfers assets to the trust while retaining the right to receive annual annuity payments for a specified number of years. Then when the trust term ends the remainder is distributed to the trust beneficiaries—typically your children or grandchildren. Typically, GRATs are funded with securities or shares in closely held business interests.
The amount of the annuity payments is based on the IRS-approved Section 7520 rate. This rate, adjusted every month, has been particularly low in recent years, and in January 2017 it was 2.4%.
A lower Section 7520 rate can be beneficial in reducing gift and estate taxes. One approach to establishing a GRAT sets the rate for annuity payments to match the Section 7520 rate when the trust is created. That "zeroes out" its impact for gift tax purposes by theoretically returning to the grantor all of the money originally placed in the trust—if there's no gift, there's no gift tax.
But if the trust assets appreciate at a rate faster than the Section 7520 rate, there will be something left for the beneficiaries, and it will go to them without any gift or estate tax implications. And the lower the Section 7520 rate—sometimes known as a hurdle rate—the more likely that outcome may occur.
That may not happen, of course, and there are at least two other possible drawbacks. If the grantor dies during the GRAT term, the assets transferred to the trust will revert to the grantor's taxable estate. In addition, GRATs have been unsuccessfully targeted by past administrations and could be subject to future tax reforms. In particular, the "zero out" technique has raised the ire of some legislators. So the benefits of GRATS could be curtailed or eliminated.
This article was written by a professional financial journalist for Pilot Capital Management and is not intended as legal or investment advice.
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