Low interest rates and looming potential tax changes make this a good time for high-net-worth clients to use a special tool to transfer wealth: the grantor-retained annuity trust (GRAT), a strategy to reduce future estate taxes by transferring assets to beneficiaries without using the lifetime gift tax exclusion.

A GRAT is funded by the grantor in exchange for a stream of annuity payments at a predetermined interest rate (a.k.a. the IRS Section 7520 rate). The interest rate was 0.4% for November and will be 0.6% for December, said David Weinstock, principal with Mazars Wealth Advisors in its New York City office.

“The GRAT assets only have to appreciate greater than that rate over the term of the trust and any excess earnings will pass to beneficiaries or ongoing trust for beneficiaries without gift or estate tax,” he noted.

“Because the grantor takes back over a period of years—usually two or three—an amount equal to what he transferred to the trust plus interest, which is set by the IRS when the trust is funded, future appreciation over and above that interest rate passes gift-tax free,” said Karen Goldberg, principal-in-charge of EisnerAmper’s trust and estate practice in New York.

And there’s little upkeep with a GRAT. “You merely execute a trust agreement and file a gift tax return to report the gift,” she added. “The trust doesn’t even need to file an income tax return if it doesn’t have its own tax ID number.”

The grantor is responsible for tax on the income generated by the assets in the GRAT, said Brandon Baker, CPA, partner and trust, estate and gift tax practice leader at Friedman LLP in Philadelphia.

If the value of the property is increased on audit, the gift won’t be increased but the annuity will. “If the GRAT property decreases, you’ll merely take back what you transferred to the trust and will only be out of pocket the setup costs,” Goldberg said.  

Assets can be anything from an investment portfolio to shares in a closely held business.

“Most GRATs are designed to have the value of the retained annuity be equal to the value of the property transferred to the GRAT,” said Gerry Joyce, New York-based national head of trusts and estates for Fiduciary Trust International. He added that if the values are equal, then the amount of the gift for gift tax purposes is zero because the value of the transfer less the annuity value is zero.

“Many of our clients are in a rolling GRAT [where] the grantor will create a GRAT and, as the grantor receives the annuity each year, they’ll use the assets received to fund a new GRAT to continually attempt to move appreciation out of their estate,” Baker said.

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