What Is a Grantor Retained Annuity Trust (GRAT)?

Grantor Retained Annuity Trusts, commonly known as GRATs, are specialized estate planning instruments. They serve a particular purpose in transferring wealth to beneficiaries. This type of trust aims to move assets from one generation to the next.

What a Grantor Retained Annuity Trust Is

A Grantor Retained Annuity Trust (GRAT) functions as an irrevocable trust, meaning that once established, its terms generally cannot be changed or revoked by the grantor. The primary individual involved is the grantor, who creates and funds the trust with assets. A trustee is appointed to manage these assets according to the trust’s provisions. The beneficiaries are the individuals or entities designated to ultimately receive the trust’s remaining assets.

Assets often transferred into a GRAT are those expected to increase in value, such as stocks, real estate, or business interests. The main objective of a GRAT is to transfer the future appreciation of these assets to beneficiaries. This strategy potentially allows for reduced gift tax implications on the transferred wealth.

How a Grantor Retained Annuity Trust Works

The mechanics of a GRAT involve the grantor transferring assets into the trust for a predetermined period, often ranging from two to ten years. In exchange for this transfer, the grantor receives fixed annuity payments from the trust throughout the specified term. These payments are typically made annually.

The value of these annuity payments is determined, in part, by the Internal Revenue Code (IRC) Section 7520 interest rate. This rate is published monthly by the IRS. The Section 7520 rate is a key factor in valuing the annuity portion of the trust for gift tax purposes. Once all annuity payments have been made, any assets remaining in the trust at the end of the term are then distributed to the designated beneficiaries.

Important Aspects of a Grantor Retained Annuity Trust

This characteristic ensures the assets are removed from the grantor’s estate for certain tax considerations. The trust also operates for a fixed term, which is specified when the trust is created, and it generally concludes at the end of this period.

The value of the gift transferred to the beneficiaries is calculated at the time the trust is created. A common structural approach is the “zeroed-out” GRAT, where the annuity payments are designed so their present value is approximately equal to the initial value of the assets transferred into the trust. This structure aims to make the initial taxable gift to the beneficiaries negligible or zero for gift tax purposes. Assets selected for a GRAT should ideally be those expected to grow significantly, exceeding the Section 7520 rate, for the strategy to result in wealth transfer to beneficiaries. Establishing a GRAT involves complex legal and financial considerations, making it advisable to consult with legal and financial professionals for proper setup and compliance.