A GRAT is a Grantor Retained Annuity Trust and is a special type of irrevocable trust that allows the settlor, or trust maker, to transfer assets to this trust and receive an annual annuity payment for a certain amount of years. When the term of the GRAT ends, the assets remaining in the GRAT are distributed to the trust beneficiaries.
So how does it work?
The amount of the annuity payment paid to the settlor during the GRAT is calculated by using an interest rate determined by the IRS called the section 7520 interest rate. The settlor can even set the annuity payment so that it will be exactly equal to the section 7520 interest rate, meaning that theoretically all of the assets that been transferred into the GRAT will be returned to the settlor in the form of annuity payments.
So why is a GRAT used?
Putting assets into a GRAT is essentially making a gamble that the assets transferred into the GRAT will appreciate in value above and beyond the section 7520 interest rate. So the settlor will receive the annuity payments, and the beneficiaries of the GRAT will receive the trust’s assets at a value that has appreciated over the interest rate.
What are the drawbacks to using a GRAT?
When the section 7520 interest rate is low, assets that are expected to highly appreciate in value can be moved into the GRAT and leave the beneficiaries a significant amount of assets when the GRAT ends. The gamble is the assets transferred into the GRAT could grow at a rate lower than the section 7520 rate. If this happens, the settlor will simply receive back the trust property at its depreciated value and will only be out the legal fees needed to set up the GRAT. Another gamble the settlor takes is that he or she could pass during the term of the GRAT. If the settlor dies, then all the property transferred into the GRAT would revert back into the estate of the settlor and face other estate taxes.
So how does the GRAT look for 2015?
This year it is widely expected that the Federal Reserve may increase the interest rates. Regardless, a GRAT could still be a smart decision if the trust holds assets that appreciate quickly, such as a stake in a company expected to go public. These are assets that are sure to double or triple in value, so therefore increasing GRAT rates shouldn’t really affect those assets.
What are some alternatives to the GRAT?
One great alternative to the GRAT is the qualified personal residence trust, or QPRT. This type of trust allows a settlor to remove a personal home from his or her estate for the purpose of reducing the amount of gift tax that is incurred from transferring assets to a beneficiary. Instead of an annuity payment, the settlor retains the right to live in the house during the length of the trust. The trust will freeze the value of the property at the time of creation, but the way the value of the house is calculated can lead to a lower gift-tax bill. This is a great way to transfer a home to a loved one and face much less taxes. For more information on how to grow your assets through estate planning, contact our office today.