What's so great about a GRAT?
Given today's low interest rates, now is an ideal time to create a GRAT, which should sit at hthe top of any sophisticated estate planner's list of gifting strategies. The reason? While technically, GRAT stands for “Grantor Retained Annuity Trust.” A friendlier acronym might be: Gift Returns Appreciation Transfers.
Here is how it works:
You create an irrevocable trust. You can retain control as the trustee and report income as the taxpayer on your personal returns. You can structure the trust so that no gift tax return is required. You can decide what to put in, how long the trust should last, and how often you will take annuity payments. The GRAT can hold anything: cash, public or private stock or real estate. With the goal of paying little or no estate tax, your advisor calculates the annuity amount by using the IRS’s published “applicable federal rate" (known as the 7520 rate). You get the value of the gift back along with what the IRS considers a fair rate of return. If you outperform the IRS rate, the children get the “upside.” In sum, you can potentially make a gift that is not a gift for tax purposes.
Here is why it works now:
Interest rates are low and not expected to rise significantly in the short term. The IRS assumes an interest rate of 1.4% for August 2016. If you think you can achieve more than a 1.4% return over, say, the next five, 10 or 20 years, then you should consider funding a GRAT immediately.
For pessimists, the GRAT could be a useless drafting expense should you die during the term, or if values drop so much that you get back everything and nothing passes to the children. Still, there is no adverse tax consequence. For optimists, the GRAT offers the satisfaction of your children receiving wealth while you can watch and guide them, and of course, the joy of doing so with little or no gift tax.
Here is what you can expect:
The successful GRAT allows you to preserve your gift, estate and generation-skipping tax exemption on wealth transfers. Most high net worth families have used up these exemptions and face a minimum 40% tax on any future transfer. As wealth appreciates in the hands of an older generation, the IRS is a partner in this added value. When you set up a GRAT today, you are freezing your net worth and shifting appreciation to the next generation and beyond.