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GRATs are Great!
Published Date : April 28, 2020
April 28, 2020
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
Articles and Commentary
Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.
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All video presentations discuss certain investment products and/or securities and are being provided for informational purposes only, and should not be considered, and is not, investment, financial planning, tax or legal advice; nor is it a recommendation to buy or sell any securities. Investing in securities involves varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular client’s financial situation or risk tolerance. Past performance is not a guarantee of future returns. Individual performance results will vary. The opinions expressed in the video reflect Sand Hill Global Advisor’s (“SHGA”) or Brenda Vingiello’s (as applicable) views as of the date of the video. Such views are subject to change at any point without notice. Any comments, opinions, or recommendations made by any host or other guest not affiliated with SHGA in this video do not necessarily reflect the views of SHGA, and non-SHGA persons appearing in this video do not fall under the supervisory purview of SHGA. You should not treat any opinion expressed by SHGA or Ms. Vingiello as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of general opinion. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based solely on any information provided on this video. There is a risk of loss from an investment in securities, including the risk of loss of principal. Neither SHGA nor Ms. Vingiello guarantees any specific outcome or profit. Any forward-looking statements or forecasts contained in the video are based on assumptions and actual results may vary from any such statements or forecasts. SHGA or one of its employees may have a position in the securities discussed and may purchase or sell such securities from time to time. Some of the information in this video has been obtained from third party sources. While SHGA believes such third-party information is reliable, SHGA does not guarantee its accuracy, timeliness or completeness. SHGA encourages you to consult with a professional financial advisor prior to making any investment decision.
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