Estate planning attorneys routinely look for ways to help their clients with little risk. There is a strategy which can be used to pass significant value to the next generation without the use of any lifetime applicable exclusion.
The strategy is the Grantor Retained Annuity Trust or “GRAT.” With a GRAT, the grantor retains the right to annuity payments during the term of the trust. Whatever is left over at the end of the term goes to the remainder beneficiaries such as the grantor’s descendants. It is possible to set the annuity payments to the grantor sufficiently high so that the gift to the remainder beneficiaries is actuarially valued at zero. This “zeroed-out” GRAT is a no lose proposition.
In zeroing out the GRAT, it is assumed that the GRAT will earn a rate of return equal to the rate under I.R.C. § 7520. For example, if you contributed $100,000 to a GRAT when the 7520 rate was 3%, the annuity payment to the grantor would need to be $103,000. Everything left after the $103,000 payment would remain for the remainder beneficiaries. This strategy is heads you win, tails you don’t lose. If the strategy is effective, you may have removed substantial wealth from the taxable estate at no transfer tax cost. If the strategy is not effective, you have not wasted any applicable exclusion.
The shortest approved term of a GRAT has been two years. Short-term GRATs can take advantage of the volatility of the underlying asset. During a two-year period in which the asset appreciates faster than the 7520 rate, the GRAT would be successful. During a two-year period in which the asset declines, all of the funds would end up back in the grantor’s hands: no harm, no foul.
In the near future this strategy may be too good to be true. There are administration proposals to close this “loophole” by requiring: 1) A minimum remainder interest of 10% of the value of the GRAT and 2) A minimum term of 10 years. These proposals would reduce but not eliminate the benefit of the GRAT.
It is expected that any legislation would grandfather existing GRATs. So, prudent estate planning attorneys are setting up trusts now to take advantage of this strategy to the benefit of their clients. Act fast—before Congress does!
Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys
Direct Line: (858) 300-4739