How ‘GRATs’ Can Minimize Taxes on Large Gifts to Family Members

Gifting assets to family members while you are alive is a great way to avoid estate taxes after you pass away. The IRS, however, also knows this and applies gift taxes to various wealth transfers. A skilled estate planning attorney can help craft innovative solutions to resolve the dilemma, and one such method is a Grantor Retained Annuity Trust.

A Grantor Retained Annuity Trust, or GRAT, is an irrevocable trust that allows for the person establishing the trust, known as the grantor, to pass a significant amount of wealth to family members with little or no gift tax cost. Once established, the grantor transfers estate assets to the GRAT which in turn pays the grantor an annuity for a limited period of time. Annuities are a series of payments made over equal time intervals, and the GRAT annuity payments would derive from an IRS interest rate called the 7520 rate. 

The grantor also retains the right to receive the original value of the assets contributed to the trust upon its expiration. Anything left over would go to the grantor’s family members, or another trust benefiting the grantor’s family, tax-free. 

Why would someone set up an irrevocable trust only to receive the original value of the trust’s assets? In a word, appreciation. When estate assets are undervalued and placed in a GRAT, the grantor can receive the annuity payments and the original investment while his or her beneficiaries receive the appreciation on those assets. This makes GRATs attractive wealth transfer vehicles when asset prices are depressed, like the current COVID-19 bear market. 

GRATS can also lower the taxable portion of large estates. Right now, the federal estate tax exemption is $11.58 million, meaning anything over that threshold could incur up to a 40 percent estate tax. A GRAT can be used to freeze the value of an estate by shifting all or some of the expected appreciation onto an estate-holder’s heirs. For example, if a person had an estate worth $10 million but it was expected to grow to $12 million over the next few years, they could transfer assets to the GRAT, pay themselves an annuity, leave their family members remaining GRAT assets tax-free, and lower their estate tax risk. 

Like many estate strategies and wealth transfer techniques, GRATs are complex and depend on a number of factors relevant to individual estates. We encourage you to contact our experienced estate planning firm for more information now or any time in the future.