Planning when Interest Rates fall - the GRAT (Grantor Retained Annuity Trust)

Millions of homeowners take advantage of a low interest rate environment by refinancing their home mortgages. However, low interest rates also make certain estate planning vehicles particularly attractive. A Grantor Retained Annuity Trust (GRAT) is one such vehicle that may facilitate the transfer of wealth to the next generation with little or no transfer tax cost.

A GRAT is an irrevocable trust funded with a single contribution of assets, which pays a percentage of the initial contribution, either fixed or with a predetermined increase (the annuity), back to the donor for a term of years, and then distributes the assets remaining at the end of the term to beneficiaries other than the donor.  

The objective of a GRAT is to shift future appreciation on the assets contributed to the GRAT to others at a minimal gift tax cost.  For the strategy to be successful, the assets transferred to the GRAT must appreciate at a rate greater than the IRS assumed rate of return.  The difference between the actual rate of return on the investment and the IRS assumed rate of return will pass, gift tax free, to the beneficiaries at the end of the GRAT term.  

With this estate planning vehicle, a donor transfers assets to a trust from which the donor retains the right to receive an annuity for a set period of time (for example, four years), after which time the remainder passes to the donor’s children or other beneficiaries, either outright or in trust.  Under the terms of the GRAT, the donor retains the right to receive an amount equal to the value he or she transferred to the GRAT plus interest, and the remainder beneficiaries receive everything in excess of that value.