Summary: To make great decisions for your GRAT you need to think creatively. The following checklist will help. But for those who missed the lecture on GRATs in acronym school, it stands for Grantor Retained Annuity Trust. It is a trust to which you can transfer assets, receive back an annuity for a specified number of years and thereafter the appreciation of the assets in the GRAT in excess of a federally mandated hurdle rate, inure to the benefit of your children. It’s a great estate tax plan for many well do to folks. As with all planning techniques, a broad perspective considering a range of issues, will server you best.
√Financial: Which assets should go into which GRAT? How should your overall asset allocation be placed in your GRATs and other trusts (asset location). Should you use single asset class GRATs? Be sure that your wealth manager leads the way with whatever investment strategies are optimal.
√Term: How long should your GRAT last? A common planning approach has been to use two year GRATs and to re-GRAT the large annuity payments each year. But the Obama administration has proposed 10-year minimum GRATs. So the 2 year re-GRAT’ing game may be in the ninth inning. Should you use a long term GRAT to lock in the current low interest rate hurdles?
√Legal: State law considerations – should you be in Delaware? How should grantor trust status be structured? How should power to substitute be used?
√Remainder Beneficiary: If your GRATs succeed, who should get the benefits? If you name children, should their distributions be outright or in trust? Trusts are preferable from a tax, control, safety and flexibility perspectives, but what terms? If the remainder beneficiary is a trust should that trust be a grantor trust after the GRAT term? That would permit you to continue to pay the income tax on trust earnings even though your children are the beneficiaries. That’s a powerful wealth transfer technique! What about naming your insurance trust (ILIT) as remainder beneficiary? That can provide a very tax efficient method to shift dollars into the ILIT without being limited by annual gift tax exclusion amounts. If your ILIT is party to a split-dollar arrangement the GRAT proceeds can be used to tax efficiently rollout (unwind) that arrangement.
√Accounting: If funded with business or real estate interests rather than stock, proper operation of entities held by the GRAT is essential. Have your CPA review of expenses and deductions on entity to avoid indirect additional contribution to GRAT, maintain records for the trust and monitor payments. If you’ve been earning a $1M salary and cut it to $250,000 and a GRAT owns 50% of the stock in the business that could be viewed by the IRS as an additional gift of $375,000 to the GRAT thereby disqualifying it.
√Annuity: Some advisers prefer the annuity be paid based on a December 31 year end so that it is due when you’re your April 15 tax return is due. Easier to remember. Some recommend that the annuity be paid based on the anniversary date of the GRAT. But that can be a funky date more easily overlooked. With a two year GRAT basing it on the anniversary date means two annuity payments instead of one. However, if the Obama 10 year GRAT rule is enacted, it would mean 11 instead of 10, not such a big deal. While you can defer the annuity payment until say April 14. Doing so might give you more opportunity to grow assets outside your estate. However, if interest rates are insignificant, or you don’t anticipate market appreciation of other GRAT assets that will be paid out, waiting may actually be detrimental.
√Insurance: Have your property and casualty insurance consultant review business and real estate transferred to GRATs to assure that they are properly insured. Using life insurance to back stop mortality risk of GRAT is important to evaluate if you use longer term GRATs. While it can be done for a two year GRAT few view the risk as worth addressing. But if the Obama administration 10 year minimum GRAT term is enacted, buying a term policy to backstop your GRAT (if you die before the GRAT ends all the assets are back in your estate) will become commonplace.
√Trustee: Some wealth managers prefer a domestic trust (formed in your state of residence) with you the grantor as the sole trustee since this simplifies it all, and gets plan in place cheaper. However, your estate planner may prefer an institutional trustee and basing the trust in Delaware, South Dakota, Alaska or another state with favorable laws and taxation.
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