If you plan to pass a substantial amount of wealth to your heirs and are concerned about minimizing gift taxes, you may want to consider whether a grantor retained annuity trust, known as a GRAT, should be part of your estate plan. A GRAT is a type of trust in which the grantor makes a one time, irrevocable transfer of assets to a trust and receives fixed payments from the trust for a specified number of years.
Grantor retained annuity trusts are particularly beneficial in low interest rate environments, so GRATs are now in favor. To learn more about how reducing gift taxes can allow you to pass more of your estate to your heirs, see gifts and gifting.
At the end of the trust term, the trust typically terminates and the trust assets pass to the remainder beneficiaries of the trust, which may be the children of the grantor or other named beneficiaries. For large estates, a grantor retained annuity trust can be a tax efficient way to pass assets to the next generation. See other types of trusts.
Grantor Retained Annuity Trust Advantages
In situations where estate and gift taxes would otherwise reduce the amount that is passed on to children, grandchildren, and other heirs, a GRAT offers several advantages. Provided the grantor survives the term of the trust, assets gifted to the trust are valued when placed in the trust rather than on the date distributed to beneficiaries. Because assets transferred to a grantor retained annuity trust may appreciate in value after the gift is made via transfer to the trust, the dollar value assigned to the gift by the IRS may be much less than if the grantor kept the assets in his or her estate and passed them to beneficiaries via a will or intestate succession.
In addition, this type of irrevocable trust allows the grantor to continue to receive income from trust assets for a determined number of years, while knowing that the beneficiaries of the trust will receive an inheritance.
Comparing Types of Estate Planning Trusts
If you are unsure whether a grantor retained annuity trust is necessary to achieve your estate planning objectives, start by comparing the advantages and disadvantages of the many types of trusts available. After you go through the time consuming procedures to set up a complex tax saving trust, it will be difficult to change, so it is important to fully understand whether the type of trust you are considering is necessary and appropriate for your unique circumstances. To compare different types of trusts used in estate planning, see
estate planning trusts.
Grantor Retained Annuity Trust Disadvantages
While a grantor retained annuity trust can reduce the amount of estate and gift taxes that would otherwise be owed, a GRAT does have several potential disadvantages.
First, the grantor must survive the term of the trust. If the grantor does not live beyond the expiration of the trust term, the assets transferred to the GRAT will revert back to the estate of the grantor and be counted as part of the grantor's gross estate for tax purposes. See estate taxes. If the grantor does not survive the trust term, the tax benefits of setting up this type of trust are negated.GRATs are often set up for terms as short as two years because the grantor must survive the trust term to achieve the tax benefits. As a result, the maintenance costs on this type of trust are very high. Complex calculations and asset valuations are required to establish a grantor retained annuity trust and comply with IRS regulations. It is very expensive to set up this type of trust, so the anticipated tax savings must be substantial enough to warrant the legal fees and related costs of including a GRAT in your estate plan. See
Trust Administration Fees. You should only establish a GRAT based on sound advice from a CPA, financial advisor or attorney.Another disadvantage of the grantor retained annuity trust is it is irrevocable. A GRAT should not be included in an estate plan if the grantor may have a need for trust assets during his lifetime or could have a change of heart about how he wants to distribute his estate. It is also important to keep in mind that while the grantor receives an income stream from trust assets during the term of the GRAT, that income stream terminates upon expiration of the trust.
Types of Assets to Fund a GRAT
The assets used to fund a grantor retained annuity trust should be assets the grantor expects to appreciate substantially during the term of the trust. The types of assets typically transferred to GRATs are stocks, real estate, and interests in a business or partnership. If you own a business and want to pass the business on to your children, you may consider using a GRAT as part of a business succession plan.
The value of assets gifted to the trust is calculated on the date the trust is created. If you do not think the assets you would consider transferring to a GRAT will appreciate substantially during the trust term, this type of trust is not an appropriate estate planning strategy. To review the advantages and disadvantages of other types of trusts, see more about trusts.
Income Payments to Grantor Under GRAT
When a grantor retained annuity trust is established, fixed income payments to the grantor must be set based upon the Internal Revenue Code Section 7520 interest rate. The grantor receives these fixed payments throughout the trust term. To find out the Section 7520 interest rate for a particular month, refer to the
IRS website. The objective when establishing this type of tax saving trust is to fund the trust with assets that will appreciate at a rate in excess of the Section 7520 rate. Assets remaining in the trust at the end of the trust term pass to the named beneficiaries.Copyright 2020 Pennyborn.com. ALL RIGHTS RESERVED.
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