Tax & Estate Strategies: What is a GRAT and Do You Need One?

GRAT stands for Grantor Retained Annuity Trust. This is a temporary irrevocable trust that may be used to transfer large sums free of federal gift or estate tax. While this may seem a complex concept to some, it can be as simple as 1, 2, 3.

1. The GRANTOR, establishes and funds the GRAT with Assets
2. The GRAT, or the Grantor Retained Annuity Trust, pays the grantor an annuity
3. BENEFICIARIES, receive assets free from estate or gift taxes

The Grantor will establish the trust for a specific term of years, while retaining the right to receive an annuity from the trust for as long as it exists. When the trust ends, the remaining assets pass to beneficiaries who are typically family members. The value of that remainder interest is a taxable transfer subject to gift tax when the trust is funded. However, by changing the duration of the trust or the size of the annuity, the value that is subject to gift taxes may be brought down to nearly zero.

According to recent reporting in Pro Publica, more than half of America’s richest 100 families have used GRATs or similar trusts to move wealth within the family at low tax costs. For example, Steve Jobs’ widow, Laurene Powell Jobs, reportedly transferred half a billion dollars to family and friends after his death via GRATs, saving some $200 million in gift tax obligations.

Because GRATs have the potential to provide significant tax benefits when interest rates are low, today’s interest rate environment may provide a good opportunity. It must be noted that potential tax legislation may alter the tax benefits of GRATs, and rising interest rates and market valuations could reduce the effectiveness. Whenever considering wealth transfer strategies, you should consult your estate planning advisors to learn more.