Historically, wealthy families have strived to reduce transfer taxes while retaining a continuing interest in the underlying property without running afoul of changing tax laws. For those individuals wishing to maintain control and a right to distributions from the property for a period of years, a Grantor Retained Annuity Trust (GRAT) can be a viable alternative.

Consider a Grantor Retained Annuity Trust if you are looking to maintain control of—and a right to distributions from—a property for a period of years. A GRAT entails a lifetime transfer of cash or property into a trust in exchange for an annuity payable to the grantor for a fixed term of years. Any property remaining in trust upon expiration of the annuity term passes to the remainder beneficiary (presumably the grantor’s children) at no additional gift tax cost. As part of the Internal Revenue Code, a GRAT offers predictable tax results. In the right circumstances, a grantor can exclude property from their estate with minimal to no gift tax costs, yet still retain control and benefit from the trust property during the trust term. Accordingly, there is virtually no downside estate planning risk.

1. When should one utilize a GRAT?

A GRAT is an effective estate freeze technique and is most applicable with taxable estates that would exceed the applicable exclusion ($5.34 million in 2014). It is a tax efficient way for a grantor with an appreciating estate and potential significant tax exposure to maximize his or her family wealth transfer desires.

The transfer to the GRAT must be irrevocable

Advantages:

Rapid appreciation during GRAT term

Cash flow advantages—Trust property generates sizable cash flow. This may allow the cash flow to meet the required annual annuity payments and enable the trust corpus to remain in the GRAT and ultimately pass to remainder beneficiaries

Availability of gift tax valuation discounts

Enhanced gift tax leverage as a result of sequential or cascading GRATs (see FAQ #8)

Disadvantages:

Mortality risk

Under-performing investment returns (a GRAT must outperform the §7520 rate during the GRAT term to be beneficial)

Carryover basis for trust beneficiaries (This situation may result in increased income taxes on a future sale.)

Transfers to 3rd or 4th generation beneficiaries (Such transfers are atypical with a GRAT as it is generally an inefficient tool for generation-skipping transfers.)