Long-term GRATs remain viable and can be a powerful tool for effective wealth transfer planning, especially where interest rates are low and asset values are depressed but expected to rise.
A grantor retained annuity trust (GRAT), is an estate planning instrument used to transfer large (appreciating) assets to future generations. Properly structured, a GRAT can serve to both maximize the value of the gift and minimize (or eliminate) estate and gift taxes.
Here’s how it works, and why this planning strategy is so popular right now. The person establishing the trust (referred to as the grantor/donor) transfers property into a GRAT, the terms of which provide that the grantor will receive a fixed annuity each year, usually for a term of years. At the end of the term, the beneficiaries get whatever is left. Because the retained annuity is calculated to (theoretically) equal the value of the remainder, there is no gift tax at the time the trust is established. For the GRAT to succeed, the underlying assets must grow, over the term of the trust, by at least the amount of the applicable discount rate specified in IRC §7520, commonly referred to as the 7520 rate. If assets in the trust outperform the 7520 rate, the excess value will pass to the heirs both gift and estate-tax free. Currently, that rate is set an historical low of 2.6%. Because of this extremely low rate, GRAT-planning strategies can be highly effective for transferring significant family wealth, while avoiding gift taxes.
It seems, however, that Congress is targeting certain types of GRAT-strategies, known as “short-term” or “rolling” GRATs. One “catch” to the GRAT strategy is that, to be successful, the donor must survive the term of the trust. Should the donor pass before the trust terminates, then the GRAT fails. For this reason, some wealth advisors have structured short-term (two-year) or “rolling” GRATs . According to Forbes.com, “a bill co-sponsored by 10 senators (relating to an extension of COBRA premium assistance) was introduced at the end of June containing provisions targeting GRATs, the most significant of which requires GRATs to have a minimum term of 10 years. So it appears that some form of this anti-GRAT legislation will eventually become law. Further, any such legislation would most likely be effective upon enactment, as provided in the prior bills.”
At this point, given the legislative environment, short-term or rolling GRAT strategies may not be advisable, though the longer-term GRAT strategies remain viable. For those who wish to make large transfer of appreciating assets to future generations, a long-term GRAT strategy may work very well to maximize the final value of the gift while also avoiding estate and gift taxes.
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