What You Should Know About a Grantor Retained Annuity Trust (GRAT)
In a 1789 letter, Benjamin Franklin is said to have written: “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”
A grantor retained annuity trust is used to minimize taxes on large financial transfers to family members. It is an irrevocable trust set up for a specified period of time. When the trust is established and assets deposited, taxes are paid. An annuity is paid out annually, and when the trust expires, the beneficiary receives the assets tax-free. This avoids significant inheritance and gift taxes.
The grantor can’t revoke the trust, but the planned annuity payments are designed to allow the grantor to receive the original contributed value of the assets over the life of the trust. The rate of return allowed for the trust is set by the IRS and is known as the 7520 Rate. The annuity payments are from the interest earned on the value of the assets.
It’s a good planning tool for passing assets with minimized tax liability. However, should the grantor die before the trust expires, the assets become a part of the taxable estate and the beneficiary receives nothing from the trust.
When are GRATs, Grantor Retained Annuity Trusts, Used?
Wealthy individuals find GRATs to be of value when they have plenty of funds for their lifestyle, and they want to plan for passing wealth on to their heirs without a huge tax bite. They can set up a GRAT with a large deposit of assets that are sitting in interest-bearing accounts anyway. The assets then generate income for the grantor over the life of the trust, and the beneficiaries receive the assets tax free.
The advantage of the GRAT is that the grantor has the assets earning interest anyway, and they can plan the GRAT’s returns to accomplish their interim income goals while cutting future taxes significantly when the assets pass to the beneficiaries.
GRATs are popular with startup business founders who have stock holdings in their own companies. One major example is Mark Zuckerberg. The exact amounts aren’t public information, but his pre-IPO stock went into a GRAT before taking Facebook public. One estimate is that the value of that stock was more than $37 million.
Disadvantage of a GRAT
The main disadvantage of a GRAT is that it is irrevocable. It’s well-planned from a financial perspective, but the risk in not being able to revoke it is in the personal aspects. Once the assets are deposited and the GRAT is in effect, the beneficiary(ies) are going to get the proceeds tax-free at the end of the GRAT’s term. If during the life of the GRAT there are personal events or changes that would have made a difference at the inception, there’s nothing the grantor can do.
Suppose your beneficiary becomes a financial, business, or personal enemy during the period. If so, you may be seething thinking about all the money they’re going to get, but there will be nothing you can do about it.
Go out and be successful, and grow your wealth, Then you can consider whether a Grantor Retained Annuity Trust is right for your tax and estate planning.