Grantor Retained Annuity Trust Case Study
Estate Plan Concerns
Bill would like to make a large gift to his children. The asset that Bill has in mind is presently worth $1,000,000, but is expected to grow in value at a high rate (9%) and produce significant income (5%) for the foreseeable future.
► Gift Now Saves Taxes But Uses Exemption
He has been informed that gifting this type of asset, now, could save a large amount of estate taxes at his death. However, he also is aware that such a large gift would require him to use his entire $1,000,000 lifetime gift tax exemption to avoid gift tax, and he wonders whether there might be a better way to transfer the asset to his children.
Estate Plan Solution
After further consideration, Bill decides to implement a technique known as a Grantor Retained Annuity Trust (GRAT), which will permit Bill to transfer the asset to his children, while using only a minimal amount of his gift tax exemption to shelter the gift from gift tax. Assuming that Bill is alive when the annuity ends, the remaining asset is distributed from the GRAT to the children free of gift or estate tax (or alternatively, the asset could be retained in trust and managed for the children’s benefit).
Grantor Retained Annuity Trust Process
- Bill (as grantor) creates an irrevocable trust for the benefit of his or her children, but reserves the right to receive an annuity for a specified period of time (10 years is chosen for this particular scenario).
- Bill transfers the $1,000,000 asset to the trustee of the GRAT.
- The value of the gift for gift tax purposes is only $1.
- Bill receives an annuity of $129,505 for a period of 10 years. At the end of this annuity term, Bill’s interest in the trust ceases.
- Thereafter, the assets are either distributed outright to Bill’s children or retained in trust to be managed and administered for their benefit. If Bill lives beyond the annuity of term, the assets pass to the children free of estate tax. However, if he dies during the annuity term, the value of his retained interest is includible in his gross estate for the purpose of computing the Grantor’s federal estate tax.
- Tax-Free Inheritance: Assets remaining in trust eventually pass to children free of estate tax (assuming grantor is alive at the time the annuity ends).
- Efficient Use of Gift Tax Exemption: A large amount of wealth can be transferred free of gift and estate taxes using a relatively small amount of the grantor’s gift tax exemption.
- Method of Low-Tax Gifting if Exemption Already Used: A great way to gift assets at little or no gift tax cost even after grantor has used up his or her gift tax exemption.
- Grantor Annuity: Grantor retains the benefit of an annuity for specified period of years.
- Integrates with Other Techniques: Can be used effectively with other planning techniques to enhance results.
A Grantor Retained Annuity Trust (GRAT) is a special type of irrevocable trust that can be used by an individual to transfer assets to his or her children free of gift and estate taxes, provided that it satisfies the requirement of Treasury regulations under Internal Revenue Code §2702. The individual, as grantor, creates the trust for the benefit of his or her children, but retains a right to receive from the trustee a specified annuity for a specified number of years. At the end of the annuity term, the grantor’s interest in the trust ends, and assets are either transferred to the children, outright, or held in trust to be managed and administered for their benefit.
► Tax-Free Transfer if Grantor Outlives Annuity Term
The taxable gift to the children for gift tax purposes is determined at the time the grantor transfers the assets to the GRAT and is calculated by subtracting the actuarially determined value of the grantor's retained annuity interest (using tables provided by the IRS) from the value of the assets transferred. If the grantor outlives the annuity term, the assets pass to the children (or in trust for their benefit) free of gift and estate taxes. On the other hand, if the grantor dies during the annuity term, the value of the assets held by the GRAT would be includible in his or her gross estate for federal estate tax purposes.
► Trust Funding Should Have Strong Growth Potential
Generally, the trust should be funded with assets that have a strong potential for significant future growth. Other planning techniques may be used with the GRAT to increase the amount of wealth that is ultimately transferred to the children.
► Calculations Will Vary According to Current Market
Unless otherwise stated, actuarial calculations are based on the assumptions that the client is 65 years old and the Applicable Federal Rate (AFR) is 5.00%.
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The following notice is required by the IRS: Any U.S. Federal tax advice contained in this communication is not intended to be written or used, and cannot be used or relied upon, to avoid tax-related penalties under the Internal Revenue Code, or to promote, market or recommend to another any tax-related matter addressed herein.
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