On September 16, 2021, Sand Hill CIO Brenda Vingiello, CFA joined the CNBC Halftime Report panel once again and discussed what positive catalysts investors canread more
GRATs are Great!
A GRAT may sound like a character from a Dr. Seuss book, but in reality, it is a great estate planning tool for clients with large estates who are concerned about paying gift and estate taxes. A Grantor Retained Annuity Trust, known as a GRAT, is an irrevocable trust established by an individual (the grantor) hoping to “freeze” the value of their estate at its current size and shift future appreciation on the assets owned in the GRAT to beneficiaries, typically their children, estate tax free. Additionally, the grantor wants to maintain control over the assets and retain a current income stream for the term of the GRAT. Does this sound too good to be true? Well, like many good things in life — and investing for sure! — there is little reward without some risk.
The term of a GRAT can range anywhere from a minimum of 2-3 years up to 10, 12 or 15 years. The term is specified in the trust document when the GRAT is established, which is important because the grantor must outlive this time period in order for the GRAT to be successful. What if the donor dies during the GRAT term? Like a boomerang, the GRAT assets are pulled back into the grantor’s estate for tax purposes. For this reason, a GRAT is typically recommended for an individual with a better-than-average probability of outliving the term of the trust. If you are healthy with a long life-expectancy, this is probably not a risk you need to be concerned about.
To be successful, a GRAT must perform better than the IRS Section 7520 rate, also known as the “hurdle rate”, which is published monthly and tied to interest rates. Like the term, the hurdle rate is set when a GRAT is established. The hurdle rate for GRATs established and funded in May 2020 is an extremely modest 0.8%.¹ This is a pretty low bar for returns on long-term investments, making it an ideal time to establish a GRAT if you are contemplating doing so — before interest rates and the 7520 rate begin to rise.
What if the performance of the assets in the GRAT merely equal or fall below the hurdle rate? Like a boomerang, the assets in the GRAT are returned to the grantor as though the GRAT never existed. The only additional loss, beyond the depreciation of the assets, is whatever was paid in estate planning fees to establish the GRAT. However, if you happen to hit a home run and the performance of the assets in the GRAT exceeds the hurdle rate, the excess value is transferred to the beneficiaries at the end of the term free of estate or gift tax — which was the whole purpose of establishing the GRAT in the first place.
You might be wondering, “Are there gift tax consequences when I establish a GRAT? And who pays the income taxes going forward?” Because the grantor must receive annuity payments at least annually, which in total is roughly equal the value of the assets contributed to the GRAT, the gift tax is essentially “zeroed out”. This means no cash out of pocket to pay gift taxes and preservation of the grantor’s lifetime gift tax exclusion amount – truly a win/win. As with any other grantor trust, all gains/losses, income, etc. for the GRAT are reported on the grantor’s personal income tax return.
If you are in good health and eager to transfer more wealth to your heirs and want to do it efficiently, while avoiding gift and estate taxes, a GRAT might be just your thing. The time to act is now, while GRATs are essentially “on sale” given the low IRS hurdle rate.
1 – www.irs.gov
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