Colin Gerrety, CFP®, CIMA®

Colin Gerrety, CFP®, CIMA®

Colin equates success with helping others make good decisions. A DC-area native, Colin works closely with our client families to navigate the complexity of today's financial world.

Imagine a family with a sizable net worth. They’ve worked hard for their money and want to make sure that every cent possible is passed to their children without being subject to burdensome estate taxes. At the same time, they need to make sure they have enough money to cover their needs. This is a great situation for a strategic estate planning tool: the Grantor Retained Annuity Trust or GRAT.

What is a GRAT?

A GRAT is a type of trust you can create and fund with assets from your portfolio. The trust has a predefined term, usually at least two years, with a regular payment schedule for returning assets back to the creator of the trust, known as the grantor. That payment schedule must involve at least annual payments back to the grantor using a portion of the trust assets.

Despite the name, the trust usually does not invest into an annuity product. Rather, it can own a variety of assets, like stocks, mutual funds, exchange-traded funds (ETFs), or even bonds.

If the assets grow sufficiently during the trust’s term and exceed a hurdle rate, as defined by the IRS 7520 interest rate at the time of the trust’s creation, then the growth above that hurdle rate is passed to the trust beneficiaries, who can be an individual, group, or another trust. The key benefit is this: any growth above the hurdle rate is outside of the grantor’s estate and is not subject to estate tax upon their passing.

Even if the assets in the trust do not generate income, as may be the case for some stocks, then the market value of the assets can be used to satisfy the payment requirement.

This can be an immensely powerful tool to minimize estate tax, all while retaining a right to the principal plus interest.

When does a GRAT make sense?

This type of trust can be a game-changer for individuals who expect their wealth to exceed the threshold for estate tax ($12.92 million per person in 2023) and own assets primed for growth.

By funding the trust with assets that have growth potential, such as a stock fund or concentrated stock position, the growth in those assets above the hurdle rate can be shifted to the next generation, free of federal estate tax.

A key consideration of how much money to initially put into the trust, which involves a balancing act of the grantor’s spending goals during the trust term and how much they are comfortable passing to the beneficiaries at the expiration of the term, if the trust is successful.

When can a GRAT fail?

If the grantor does not outlive the trust term, then the GRAT fails, and the full GRAT value is returned to the grantor’s estate.

Additionally, if the assets in the trust do not grow sufficiently over the trust term, then the entirety of the trust is returned to the grantor, and nothing is passed to the beneficiaries. However, this is not as bad as it may seem.

It is not surprising to see certain investments negative over a two-year period or more; in fact, this should be expected from time to time. This is why “rolling GRATs” can often make sense, with a new GRAT created each year using payments from the prior GRATs. This minimizes the temptation to time the market and guess the best time to create a GRAT.

When does a GRAT succeed?

If the assets in the trust grow sufficiently over the trust term, then the full growth above the hurdle rate is passed to the beneficiaries. This can result in hundreds of thousands or even millions of dollars in estate tax savings over time.

Laws and tax rules change frequently, so a successful estate plan involves careful consultation with your attorney, financial planners, and tax advisors.

Glassman Wealth’s Guide to Grantor Retained Annuity Trusts delves deeper into the considerations involved and illustrates how a GRAT works. If you think a GRAT could make sense for you, the advisory team at Glassman Wealth can help you consider your options in coordination with your legal team.

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