But this new restriction is not expected to be too great a burden as presently proposed, since it is possible to construct a GRAT with a gift of $1 that would satisfy the requirement.
Second, the legislation would prevent the annuity payments to the client from decreasing year over year during the GRAT term. This second requirement is also not likely to affect many clients, as most choose to increase the annuity payments year over year in order to allow the assets more time to grow within the GRAT. The current GRAT regulations limit the annual increase to 20%.
The third requirement is more important, and would impose a minimum term of ten years on all GRATs. If enacted, this requirement would likely remove the GRAT as a possible planning technique for most elderly clients.
For clients who are expected to survive a ten-year term, however, GRATs may still be attractive. It will depend on interest rates, in particular whether the rates are increasing or decreasing. When interest rates are low (as they are now) and likely to increase, locking in a lower rate for a longer term can compound the benefits of that low rate, making it more likely that the GRAT will pass excess appreciation to the beneficiaries tax free. In the current economic environment, therefore, a ten-year minimum term should not dissuade younger clients from funding GRATs.
A ten-year minimum term would, however, make GRATs less attractive for all clients (regardless of age or health) in declining interest rate environments, when locking in a relatively higher hurdle rate for a long period of time would make less sense.
Sale To A Grantor Trust
A rival strategy to the GRAT is the sale of assets to a grantor trust. This is sometimes referred to as a sale to a defective grantor trust because the trust is treated as if it is owned by the client grantor for income tax purposes but not for estate tax purposes.
It works this way: The client sells assets to a grantor trust in exchange for a note from the trustees bearing interest at a rate that is at or above the minimum rates allowed by law. If the assets sold to the grantor trust appreciate at a rate greater than the interest rate on the note, the excess appreciation will remain in the grantor trust for the benefit of the trust beneficiaries.
This excess appreciation can be quite substantial because the applicable interest rates are extremely low-even lower than the hurdle rate for GRATs: The rates for sales to grantor trusts in November were 0.35% for short-term loans of three years or less, and 1.59% for midterm loans between three and nine years.
However, clients must carefully weigh the differences between the two strategies. While GRATs are specifically authorized by statute and regulations, there are no statutes authorizing sales to grantor trusts, which makes them more risky. Still, such sales are regularly used by estate planners, and private letter rulings offer some guidance on structuring them.
One guideline suggests that a grantor trust should have assets before the sale equal to at least 10% of the value of the assets sold to the trust. Accordingly, if there is no funded grantor trust available for the transaction, the client must make a taxable gift to the trust before the sale equal to at least 10% of the value of the assets that will be sold, using up some part or all of her $1 million lifetime gift tax exemption, or perhaps paying some gift tax. If a taxable gift is required, the sale technique may be less attractive than a GRAT (at least while zero gift GRATs remain possible).