For high-net-worth individuals, effectively planning to minimize estate taxation can
require creative solutions. Gifts to beneficiaries that exceed the annual gift tax or lifetime
gift and estate tax exclusions can be subject to potentially steep taxes. In 2024, the
annual gift limit is $18,000 per person per year, and the lifetime gift and estate tax
exclusion is $13.61 million—but the latter is scheduled to drop to $5 million in 2025. If
an investor has assets that they expect to grow significantly in the future, and that they
intend to hold onto to help create wealth for their chosen beneficiaries, can be at risk of
incurring a sizeable tax bill if they send the estate over the gift tax limits.
This is where a Grantor Retained Annuity Trust (GRAT) can be helpful in minimizing
taxes on large financial gifts without reducing the amount of the exclusion. When
structured effectively, it allows the appreciation on the assets in the trust to pass to the
chosen beneficiaries at the end of the trust’s term without additional gift tax.
What Is a GRAT?
A GRAT is an irrevocable trust created for a specified number of years, with the grantor
receiving annuity payments until the end of the trust term. Once assets are transferred
into the GRAT, it can’t be revoked or altered. If it is structured such that the present
value of the annuity equals the fair market value of the assets contributed (the asset
plus a rate of return known as the Section 7520 rate or “hurdle” rate), then the residual
appreciation above that rate is effectively removed from the grantor’s estate. At the end
of the term, any remaining assets are transferred to the designated beneficiaries,
usually with minimal or no gift tax implications.
This strategy depends on the actual rate of investment return exceeding the Section
7520, resulting in excess growth that passes to the beneficiaries tax-free. The grantor is
able to retain an income stream during the trust term while reducing the size of their
taxable estate, minimizing gift taxes, and leveraging asset appreciation. However, this
estate planning tool has significant limitations that must be taken into account when
deciding if it is an appropriate strategy.
Understanding How a GRAT Works
While a GRAT has flexibility in choosing its duration and the structure of annuity
payments, once it is set up it is fixed. If the grantor passes away during the term of the
trust, the remaining assets may be returned to their estate for estate tax purposes
(although this may be avoided by passing the right to receive remaining annuity
payments to a surviving spouse). This makes choosing an appropriate term of the
utmost importance—currently, a GRAT can be established for as little as two years. No
additional assets can be put into the trust once it is established, and the grantor is also
responsible for paying income taxes on the trust’s income. Most importantly, the assets
used to fund the trust should be chosen with care. If the underlying assets depreciate,
or do not appreciate as expected, there may be little to no tax advantage gained.
Situations That Work Well With GRAT
In light of those considerations, is it worth it to incur the set-up fees and administrative
costs of a GRAT? In the right circumstances, absolutely. Assets that are likely to
outperform the Section 7520 rate, such as promising startup stock, stocks that are
currently down in value but historically strong, and minority interests in a family
business, are good candidates for a GRAT strategy. This tactic also deserves
consideration for estates that are likely to exceed the lifetime exclusion. Consulting with
an experienced legal advisor who can help determine the place of a GRAT as part of a
larger estate plan designed to meet the individual’s overall wealth transfer and tax
minimization goals is strongly advised.
Expert Estate Planning for High-Net-Worth Individuals
The more complex and extensive your assets, the more likely it is that an unwitting
misstep in estate planning will result in unnecessary taxes. At Bridge Law, LLP, our
Trusts & Estates team crafts estate plans tailored to your individual circumstances, with
holistic strategies designed to benefit future generations as you intend. To learn more
about how we can help you effectively meet your estate planning goals, schedule your
consultation by contacting us here today.