No one wants to pay more taxes than they absolutely have to, and the wealthiest of citizens are no exception. One of the ways people can avoid or minimize estate or gift levies, in the form of taxes, is by transferring assets to their beneficiaries. In the United States, monies payable due to having a large estate can be huge. The tax burden can be as high as 40 percent of the taxable amounts, surpassing the exemption set by the federal government. In 2022, the exemption on estate tax assessments is $12.06 million for a single person and $24.12 million for a married couple. A grantor retained annuity trust could be just what you’re looking for.
By creating a trust that cannot be revoked, wealthy people can move assets out of their estate without having to pay taxes. To accomplish this goal, one trust that cannot be revoked and is frequently utilized by people who have substantial resources is called the grantor retained annuity trust.
A grantor retained annuity trust (GRAT) is an economic tool utilized in planning how to distribute assets and help lower taxes on sizeable financial gifts that may be left to beneficiaries. The GRAT is a trust that cannot be revoked, and it is created for a set time that has been specified. The individual creating the trust establishes a gift amount when the trust is first set up. Assets are then placed under the trust and when they mature, an annuity is disbursed to the grantor every 12 months. When the trust expires and the last annuity payment is made, the assets are then disbursed to the beneficiary who pays little or no taxes. At the same time, this also lowers the total equity of the creator’s assets, which will eventually be subject to estate tax.
UNDERSTANDING HOW A GRAT WORKS
A GRAT is an irrevocable gifting trust that permits the grantor to pass a large amount of wealth to the next generation with little to no gift tax, while at the same time earning an annuity each year. In general, a GRAT is only created for a set number of years or time intervals.
When a GRAT is first created, the grantor contributes assets to the trust but even though the trust is irrevocable, it still retains the right to receive an annuity each year. The specific amount of return on the annuity is set by the IRS (known as the 7520 rate).
During the term of the GRAT, the only beneficiary of the trust is the grantor, and the only distributions made to the grantor are the annuity payments made from GRAT. When the period of the GRAT is over, the residual assets are then disbursed to the named beneficiaries who pay little or no tax. The key benefit for the grantor is lowering the size of his or her estate and, consequently the impact of any tax monies owed due to that.
Under the GRAT, the yearly payments are derived from the interest earned on the assets in the trust or as a percentage of the total assets. If the grantor who created the trust dies before the expiration of the trust, the assets then become part of the taxable estate of the individual and the beneficiaries do not receive anything.
WHO SHOULD USE A GRAT?
The GRAT is not for most Americans; it is ideal for wealthy people who have a sizable estate and tax liability at death. In such cases, a GRAT may be utilized to cap the amount of the estate by transferring all or a portion of the estate’s appreciation to the beneficiaries.
For example, if an individual has assets worth $20 million, but this is expected to grow to $25 million over the next two years, the differential could be transferred to the children tax-free. If the grantor succumbs to death during the term of the GRAT, the amount of the residual interest now becomes part of the estate and is taxable. However, the grantor can also decline the right to receive any residual annuity payments to the surviving spouse in order to qualify for the estate tax marital deduction, which then eliminates any tax liability relating to the GRAT assets.
As a grantor retained annuity trust example, the GRAT has become popular among entrepreneurs who own large shares in startup companies as stock price appreciation for IPO shares usually far outpaces the rate of return set by the IRS. This means that more funds can be transferred to the children, while not being a part of the grantor’s lifetime exemption from gift and estate tariffs.
THE POPULARITY OF GRATS
Another grantor retained annuity trust example is when interest rates are low. Wealthy individuals utilize GRATs to pass on the appreciation of assets to their families. As long as the worth of the assets placed in GRATs exceeds the IRS “hurdle rate” (which is the minimum rate of return), the grantor is at liberty to transfer the excess profits without paying any tax. The IRS minimum rate of return is an interest rate that changes monthly; the lower the rate, the lower the appreciation required to pass the worth to the beneficiaries.
If assets in the GRAT do not add gains substantially more than the prescribed “hurdle rate,” the consequences are minimal. The creator (or grantor) will receive all the assets back in the form of annuity payments; unfortunately, the beneficiaries will not get anything.
The one downside of a GRAT is the fees that are incurred during setup. This includes legal fees, setup fees, and accounting fees. In most cases, there are also appraisal fees.
The ideal assets to contribute to a GRAT include those that have lower costs relative to their intrinsic worth but are expected to appreciate over the GRAT term.
If the grantor dies unexpectedly during the term of the GRAT, the assets will then be included in the decedent’s estate for tax purposes. It is for this reason that most grantors usually create short-term GRATs, usually for just two years.
As far as tax is concerned, during the GRAT term, the income tax liability depends on how the terms have been structured in the trust. The tax liability may be paid by the trust or the grantor.
For people who are considering creating a grantor retained annuity trust, it is important to follow the legislation surrounding GRATs because the laws are continuously changing with the changing economy. Since GRATs can help reduce or erase gift and tax liabilities, the government is planning to add more restrictions on the duration of the GRAT.
It is important to work with an expert in GRAT and estate planning so that one does face adverse consequences. An experienced estate planning attorney will usually work with your financial advisors and accountants to determine the best strategy to save money on estate tax.
Elder Law, P.A. was established to help seniors navigate the rules and regulations of trusts, wills, and estate planning, along with other avenues of taking care of a decedent’s affairs after death. Call them today at (561) 588-7512 to speak with a knowledgeable representative who can make an appointment for a free consultation to get all your questions answered.