Travis Russell

Travis Russell, CFP®

Travis employs many of the disciplines of success that he learned as a Division 1 hockey player – namely, persistence, practice, and a having passion for what you do – to his role as Principal and Client Advisor.

This article was originally published on September 14th, 2016, and updated as of July 18th, 2018.

Effective estate planning is often a long, ongoing process, and it doesn’t happen overnight. It’s difficult to remain focused on the long term benefits of different strategies, especially when they don’t work 100% of the time.

One strategy we often recommend for clients to potentially reduce their taxable estate is a grantor retained annuity trust, or GRAT. Unfortunately, GRATs can sometimes cause frustration if they don’t work the first time. Let’s dive into some of the reasons why a GRAT can still be a viable strategy, even if it doesn’t succeed the first time.

GRAT 101: The Basics for Estate Planning

In short, a GRAT is an estate planning technique that involves funding a trust with specific assets, and if those assets grow sufficiently, it moves a portion of the growth of those assets outside of the grantor’s estate – by either transferring the amount outright to one or more beneficiaries or to another trust.

During the term of the GRAT, the grantor is paid back the amount of the original contribution in the form of an annuity payment, plus a small amount of interest determined by the IRS (the 7520 rate). All growth in excess of that interest rate can be moved outside the grantor’s estate, and therefore reduces some of the estate’s tax burden when the amount of the estate exceeds the federal exemption. In 2018, the federal exemption is $11,180,000 for an individual or $22,360,000 for a married couple.

If you’re curious about the specifics of how a GRAT works, check out our GRAT Guide.

If at first you don’t succeed….try, try, again!

It’s not surprising to see some asset classes be negative over a one or two-year period. In fact, from 1926 to 2014, the S&P 500 was negative in 27% of all calendar years. [1]

We often recommend concentrated, rolling GRATs to hedge against a low or negative performing asset class over a short period of time. “Rolling” GRATs involves taking the annuity payments from the initial GRAT and re-investing the assets into a new GRAT. For clients with large enough accounts, it may make sense to create different GRATs, each with investments in one specific asset class (US stocks, foreign stocks, real estate, etc). Only one asset class needs to have strong performance to move a sizable amount of growth outside the estate. More importantly, negative performance of one asset class does not impact the potential success of the other GRATs.

To illustrate: let’s assume a GRAT is funded with $1,000,000 and the annuity payment is approximately $513,000 in year one (principal + interest). GRAT two would be funded with that $513,000. GRAT three would be funded with the annuity payments of GRAT one and GRAT two. The process would continue on an annual basis. Below is an example successfully rolling GRATs, assuming a two-year term for each GRAT and an annualized growth rate of 10% on the underlying assets:

[table id=3 /]

Take note of the power of a GRAT! Over $485,000 is moved to heirs without paying any estate or gift tax.

It’s important to remember a consistent 10% annualized return is likely unrealistic but this illustrates the structure and benefits of the rolling GRAT structure.

Now let’s take a look at the potential benefits of rolling GRATs with more realistic market returns.

Cost-Benefit Analysis (With only a 60% success rate!)

Investors must get proper tax and legal advice when implementing complicated estate planning strategies, but that cost is minimal compared with the potential benefit of reducing future estate tax for your heirs. Let’s assume the legal cost to setup each GRAT is $3,500 and a client will fund five rolling GRATs with $1,000,000 apiece. Here’s how it could play out:

[table id=4 /]

With this example, two out of five GRATs didn’t work, and the grantor paid $17,500 in legal costs. $7,000 of those legal costs provided no benefit; however, by continuing with the GRAT strategy, as you can see in the above example, hundreds of thousands of dollars were moved outside the estate, reducing the tax burden for the heirs.

Can GRATs be frustrating when they don’t work the first time? Yes. Are they likely still worth the legal costs for clients with a taxable estate who are looking to maximize the amount left to their heirs? Probably. Consult your financial advisor or estate planning attorney to discuss your personal situation.

Think Big and Long Term

A successful estate planning strategy demands continuous review, discussion, and adjustments. Families must evaluate their long term goals, needs, and legacy.

Even if a GRAT fails to work, it can still be a valuable planning strategy if you stick with it. Re-evaluate each year and decide whether another attempt makes sense. If your goals haven’t changed, stick with the process and see the amazing benefits to your family over time.

Even though you don’t need to commit to multiple GRATs when first starting out, it’s important to keep the right mindset from the start: some GRATs may not work, but the strategy can still pay off significantly down the line.


Find out more about when to consider a GRAT: check out our GRAT Guide!