Definition of GRAT Estate Planning Terms
First and foremost, to make this topic easily comprehensible, let’s define and explain some terms featured prominently in this article. This will go a long way to ease your understanding of the GRAT estate planning technique.
- Grantor: Also called a trustor or settlor, the term “grantor” simply refers to any individual or entity that sets up a trust and commits their assets to such trust (trust assets). They thus leave the control of such assets to the trustee on the agreement (trust agreement). The trustee manages the assets on the grantor’s behalf for the benefit of the trust beneficiaries.
- Trust: A trust, in layman’s terms, is an arrangement in which a party (the grantor in this case) grants the legal powers to another party (the trustee) to preside over an asset or assets (trust assets) for the sole purpose of benefiting a third party (the beneficiary). This is usually done in a bid to ensure the protection of such assets and ensure a hitch-free transfer of such assets.
- Annuity: This refers to a contract-like arrangement in which a party (the grantor in this context) invests an asset of reasonably high value or a large sum of money with an entity (insurance company) for a period of time (often long term). In return, the grantor gets guaranteed yearly payments of a particular amount of money. The annual payments are the actual annuity.
- Estate: An estate is the entirety of an individual’s assets either during their lifetime or at their time of death. This includes their real properties, personal properties, movable and immovable properties, shares of stock, and other similar assets.
- Estate Planning: Estate planning simply refers to the arrangements made to determine how a person’s assets or properties will be protected, managed, and distributed to additional beneficiaries in the event of the person’s death or incapacity.
- Section 7520 Interest Rate: This is the interest rate that is used in most cases to determine and discount the value of the payable annuity in trusts. It is 120% of the federal mid-term rate applicable for the month under section 1274 of the IRC, which gets rounded up to the closest two-tenth of 1%.
What Is a Grantor Retained Annuity Trust (GRAT)?
A grantor retained annuity trust (GRAT) can be defined, in layman’s terms, as a technique used in estate planning to greatly reduce the income taxes on large financial gifts (gift taxes) to the grantor’s beneficiaries. This technique involves the creation of an irrevocable trust for a particular period for which the grantor pays a particular amount in taxes as a taxable gift.
When an irrevocable trust gets created, the grantor’s remainder assets, such as real estate or business interests, are placed in the trust. The grantor then earns a particular amount of money in annuity each year (for every future appreciation) until the trust expires and the excess assets (also known as assets in excess) are transferred to the beneficiaries at no cost in taxes.
The amount paid as an annuity to the grantor is determined by the interest earned on the gifted assets placed in the trust each year. The actual rate of return is based on the Section 7520 interest rate or by a percentage of the remaining assets’ value.
Benefits of GRAT for Estate Planning
What are the basic benefits of a Grantor Retained Annuity Trust (GRAT) for estate planning? Basically, this arrangement allows you to retain or freeze the value of the current assets or leftover assets held in a grantor trust. These assets can then be passed on to the beneficiaries of the trust without the usual taxable gift or estate tax considerations. That’s why GRATs are often put in place for gift tax purposes or estate tax purposes.
Furthermore, Grantor Retained Annuity Trust (GRAT) for estate planning allows for the transfer of assets of a wealthy family to the trust’s beneficiaries. It incurs very few to no fees paid in gift and estate tax.
Finally, the annuity received from GRAT makes for a stable yearly source of income in the event of retirement. It also allows for the stress-free and timely transfer of ownership of properties or high-basis assets after death. So, essentially, people often choose GRAT to avoid paying huge sums in taxes, to enjoy the hassle-free income, and as a part of their estate plans to minimize probate after death.
Who Needs GRAT?
A Grantor Retained Annuity Trust is not just for anyone with annuity payments. Typically, only people whose estate values are high (high-basis assets) enough to incur estate taxes should be thinking of threading this path of estate planning. This is because of the way lifetime estate taxes exemption work.
A lifetime estate tax exemption, which is proportional to the lifetime gift tax exemption, stipulates that only estates that are worth more than $11.7 million are subject to federal estate tax. Therefore, any individual whose estate value is below that amount will not need to set up a Grantor Retained Annuity Trust for annual gift tax exclusion because they already have a lifetime exemption.
When Is the Opportune Time to Set Up a GRAT?
If your estate is valued at $11.7 million or more, you may be wondering whether now is the right time to set up a grantor retained annuity trust. The answer? It depends on the following three factors.
Depressed Assets: The best time to set up a GRAT is when assets that are usually valued high are depressed. If your normally high-value assets happen to be going through a depression in value with high potentials to appreciate, that may be the best moment to place such assets in a GRAT. Why? If the growth rate improves and the assets appreciate while placed in a GRAT, all the profit and value increment will not be part of your taxable estate. This is a win for you.
Section 7520 Interest Rate: At the time of writing, the interest rate is currently low (1.0%). Because of this, you would not receive a high annuity for a GRAT started now yearly due to the low-interest rate. This allows the GRAT assets to grow and accumulate value while being guarded against tax liabilities associated with appreciable assets.
Estate Tax Sunset: The present tax law that allows for higher lifetime gift tax savings and estate tax exemption of $11.7 million will “sunset” on the last day of the year 2025. This means that by the 1st day of the year 2026, the exemption will go back to $5.49 million. By placing your assets in GRAT to make higher profits and get higher returns before the sunset, you could save yourself a lot of trouble.
What Are the Best Assets to Contribute to a GRAT?
Which assets should you place in a Grantor Retained Annuity Trust (GRAT) estate planning tool? There are specific assets that can be placed in GRAT for assured appreciation of value (appreciation of assets). These include high-value assets such as investment portfolios, stocks and bonds, high-value real estate, high-value artwork, commercial properties, and precious metals.
What If the Grantor Does Not Survive the GRAT Term?
In the event of the death of the grantor in a grantor retained annuity trust before the completion of the GRAT term (trust term), all the rapidly appreciating assets placed in the trust will have to come out. They’ll once again be subjected to estate and gift taxes. The remainder beneficiary of such a trust will not receive the appreciated value from the trust property at the time of death of the grantor. That’s why it’s important to consider mortality risk when thinking about GRATs; there are other estate planning strategies that may work better if death is imminent.
Get Help with Your GRAT
A Grantor Retained Annuity Trust (GRAT) estate planning strategy can help you pay out large assets and additional gifts to beneficiaries while avoiding the usual gift tax cost. However, you may well have more questions regarding GRAT assets. You also may be thinking of the best type of arrangement for the type of properties or assets you own and proportional to their value. If so, please feel free to reach out to A People’s Choice.
A People’s Choice can help guide you as you plan your estate with comprehensive, up-to-date legal documents at affordable costs. By choosing the right estate planning structure for you, you can ensure your beneficiaries receive as much of your assets as possible without facing estate tax consequences. Contact us today to get started!