Grantor Retained Annuity Trusts.
Introduction: A key goal of what we refer to as “estate planning” is to preserve a legacy for your family. How can you get as much of your estate as possible into the hands of your beneficiaries. That means minimizing, if not eliminating erosion from taxes and court related fees. While there is uncertainty surrounding the future rates of gift and estate taxes, you may be tempted to put your plans on hold. But strategies now exist to pass significant assets to your beneficiaries at little or not tax cost to you. We have discussed many planning tools that leverage the gifting of assets to family members so as to minimize or avoid transfer taxes (gift and estate), such as family limited partnerships and personal residence trusts. Another such strategy is the grantor retained annuity trust. By transferring assets now, future income and appreciation of those assets also escapes transfer taxes.
How it Works: A grantor retained annuity trust (GRAT) is a type of irrevocable trust in which the grantor transfers assets into a trust that the grantor creates. The grantor receives a fixed amount annuity from the trust for a number of years. At the end of the term, any remainder in the trust passes to the grantor’s beneficiaries, such as their children.
The grantor can create a GRAT without paying any gift tax on the remainder passing to the trust beneficiaries if the value of the annuity payments is equal to the value of the property contributed to the trust. The result is commonly known as aa “zeroed out” GRAT. The trust assets just needs to appreciate in value greater than the published rate set by the federal taxing authorities for loans interest between family members. If the assets grow enough in value, and the grantor remains alive for the term of the trust, the excess appreciation is transferred without any gift or estate tax!
Increasing Effectiveness: GRATs work best with a positive volatile market. Unlike normal investing strategies, these trusts pay out more by using concentrated portfolios and a short annuity term of typically two years. A concentrated portfolio puts more volatility to work and increases the likelihood that the trust will have appreciation above the federal rate. Secondly, by structuring a short annuity term, if the assets did not appreciate enough this time, they can be “rolled” into another GRAT, i.e., the grantor sets up a series of overlapping short term trusts, using the annuities received each year to fund the next GRAT. Even if one GRAT fails to exceed the federal rate, leaving no excess for the beneficiaries, each new GRAT is a new opportunity. Even with just a few wins, the amount that goes to the beneficiaries can be impressive.
Conclusion: Taking a wait and see attitude on asset transfer planning assumes that the rules won’t change in the future. However, the history of federal taxation is one of continual change. For example, after 2010, the estate tax exemption will roll back to only one million dollars, the maximum estate tax rate increases from 45% to 55%, and the federal capital gains rate increases to 20%. The rules may change to require that a GRAT have at least a 10 percent remainder interest, such as that required by charitable remainder trusts. Today there is no such requirement: the transfer of the remainder is completely free of gift tax. Can you afford to wait and see? Planning is about being proactive while you have the opportunity. Waiting inevitably leads to the loss of opportunities. Take care of your concerns now, by taking action today
By Christopher C. Jones © September 2008