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Transferring appreciation from your estate when values are down with a Grantor Retained Annuity Trust

Estate Planning
Estate planning
Wealth preservation
Passing wealth

Transferring appreciation from your estate when values are down with a Grantor Retained Annuity Trust

Mar 15, 2022

In recent months, global events and economic conditions have led to much volatility and uncertainty in the financial markets. At the same time, interest rates remain low, but they are expected to rise. While this combination of events may cause uncertainty and even concern, the current market declines and near-all-time low interest rates present important, and timely, estate planning opportunities.

One key strategy is the use of a Grantor Retained Annuity Trust, or GRAT, to transfer appreciation of certain assets from your estate, turning depressed market values to a benefit.

What is the purpose of a GRAT?

When properly structured, and in a volatile market with low interest rates, a GRAT may be an attractive US estate planning strategy. A GRAT is an irrevocable trust created for a specified number of years. It aims to capture growth of contributed assets, and distributes that appreciation to beneficiaries without incurring any gift tax – the transfer is not treated as a taxable gift. This strategy is therefore especially effective for individuals who have already utilized their lifetime gift tax exemption.

How does a GRAT work?

The Grantor creates an irrevocable trust to hold assets for a specified term. In exchange for the transfer of assets to the GRAT, the Grantor receives fixed annuity payments back from the trust each year during the term. As a general matter, the Internal Revenue Service currently considers two years to be the minimum term for a GRAT. The annuity payments to the Grantor can be “zeroed out,” which means the funding of the GRAT will not incur gift tax if the amounts repaid to the Grantor are approximately equal to the amount funded.

In determining the amounts to be paid to the Grantor, the GRAT uses the 7520 rate in effect in the month the GRAT is funded. The 7520 rate is fixed at the time the GRAT is established, as it represents the then-relevant minimum rate of income the IRS assumes the trust will earn for the duration of the GRAT. Only income that is actually earned by assets held by the GRAT is taxable during the GRAT term and such income is taxable to the Grantor.

GRATs can be effective at transferring wealth on a gift tax-free basis whenever assets owned by a Grantor can appreciate at a rate in excess of the 7520 rate – which is why GRATs are more attractive when interest rates are lower. The 7520 rate for March 2022 is 2.0%. For a GRAT that is funded this month, to the extent assets contributed to it grow in excess of 2.0%, such appreciation can be transferred to beneficiaries without incurring gift tax or tapping into the gift tax exemption.

Finally, for the GRAT to be successful, the Grantor must outlive the GRAT term. If the Grantor dies prematurely, the value of the remainder interest in the trust is included in the Grantor’s taxable estate.

What assets should be used in a GRAT?

The best assets to fund a GRAT are those that are expected to appreciate more than the then-prevailing 7520 rate. While almost any asset can be used to fund a GRAT, those assets more readily valued provide for easier administration of the GRAT on an annual basis, since such assets may be distributed in-kind to make the annuity payments to the Grantor.

GRATs can be strategically implemented by taking investment objectives into consideration. For example, a GRAT can be funded with positions in a single stock, a particular asset class or a diversified portfolio.

What happens to the remaining assets after the GRAT term ends?

Following completion of the GRAT term, all assets remaining in the GRAT (not repaid to the Grantor via the required annuity) will be paid to one or more beneficiaries. Assuming the GRAT was “zeroed out” for tax purposes, these remaining assets can pass to the Grantor’s desired beneficiaries free of any gift taxes, and no gift tax exemption needs to be used by the Grantor. The beneficiaries are given a carryover basis for any assets received from the GRAT.

The remaining assets in the GRAT can be distributed directly to the intended beneficiaries or the assets can be held in trust for their benefit. Often, GRATs are used in conjunction with one or more other estate planning strategies. For example, assets in a GRAT at the end of its term may be distributed to an irrevocable trust owning life insurance on the life of the Grantor, and are used to pay life insurance premiums. Or the funds may be used to satisfy any required payments, pursuant to any promissory notes that have been established for any lending agreements between the Grantor, family members, and/or irrevocable trusts.

In order to continually attempt to capture further appreciation and remove it from an individual’s estate, annual annuity payments received back from a GRAT can be rolled into a new GRAT, for a series of ‘rolling GRATs’.

Our Wealth Planning and Advisory team is a group of seasoned experts who can help you identify your family’s values, goals, and objectives, provide guidance on appropriate estate, philanthropic, and family governance structures, and work with you and your legal and tax advisors to implement on your strategies.

For more information and assistance with your planning, please contact us or contact your Relationship Manager.

Market volatility can be stressful, but planning proactively can reveal strategies and opportunities to protect your wealth even in turbulent times.

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