The Grantor Retained Annuity Trust or “GRAT” is a great vehicle which may be used to transfer a great deal of value for little or no estate, gift, or generation-skipping “cost.” Thanks to some Wal-Mart heirs’ shrewd planning, this even works if the GRAT is “zeroed-out.”
Let’s take a closer look. A GRAT is a trust in which the grantor retains a right to a stream of annuity payments for a term of years. During that term, the grantor gets these payments and whatever remains goes to the remainder beneficiaries. It might go to those beneficiaries outright or in trust.
For example, the grantor could contribute $1 million into a GRAT in June 2012. The 7520 rate in that month will be an exceptionally low 1.2%. That is the rate the IRS will assume that the assets will return. Based on that, if the annual payments to the grantor were $106,718 for ten years, then the actuarial value of the remainder interest would be zero. Thus, it would be a “zeroed-out” GRAT.
Let say that the assets are invested in the stock market and earn a 2% dividend yield and a 7.5% growth in assets. At the end of the term, after making the tenth and final payment of $106,718 to the grantor, there would still be money left in the trust. In fact, based on these assumptions, there would be $828,724 left in the trust. The phenomenal thing is that these assets would go down to the beneficiaries without any transfer tax of any kind.
During the term of the GRAT, it is a grantor trust for income tax purposes. In other words, the income from the trust, the 2% dividend in our example, is taxed directly to the grantor. So, the trust is not diminished by this income taxation. If desired the beneficiaries could be left the remainder in a continuing grantor trust. Thus, the $828,724 could continue to grow tax-free for the beneficiaries.
How is this possible? It’s not in an IRA or ERISA plan. The assets would grow tax-free because the grantor would be paying the tax from his or her own assets, freeing the remainder assets from that burden.
The GRAT is such a great strategy, it has been targeted by the Administration for limiting legislation. The Administration would like to require a 10% minimum value to the remainder interest, as well as other restrictions, including a 10-year minimum GRAT term.
Right now, clients are awash in today’s $5.12 million of applicable exclusion. But, come New Year’s, clients will be much more concerned with conserving their comparatively paltry $1 million applicable exclusion. This will make the GRAT the strategy du jour in 2013. Start learning about it now!
Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555