Grantor Retained Annuity Trust

Grantor Retained Annuity Trust

By: Martin M. Shenkman, CPA, MBA, JD

Standard Use: A grantor retained annuity trust (GRAT) is a tax oriented trust to which you transfer assets, receive an annuity for a set number of years, and at the end of which your heirs (e.g. children) receive the assets. The benefit is a reduction in the value of the assets for gift tax purposes. A typical GRAT scenario might be a short 2-3 year GRAT funded with the most volatile securities in your portfolio, or a private equity deal you hope will balloon in value.

Tailored Use: The standard goal is to remove upside appreciation. However, if you are a physician worried about malpractice, perhaps a long 20-year term GRAT designed to give you an annual annuity might be a better bet. With many short term GRATs much of the principal is returned to you via the annuity payments, and therefore back to the reach of your creditors. In a long term GRAT the principal can be tied up in an irrevocable trust until after you retire. The annual annuity payments are reachable by a claimant, but the principal is in an irrevocable trust. Same technique, same governing legal document, but completely different application.

Key: It's not only about gift tax minimization, but asset protection as well.

GRATs and Grandkids: GRATS are a great technique to leverage gifts to children without gift tax. They are not used for grandchildren (skip persons) because you cannot allocate GST exemption to avoid the Generation Skipping Transfer tax on gifts to grandchildren until the GRAT is over and the property presumably appreciated. If you've used up your $1 million lifetime gift exclusion, made no gifts to grandchildren, and don't contemplate future large gifts to grandchildren, you might use a GRAT to leverage gifts to grandkids even if the allocation of GST exemption at the end of the GRAT term is inefficient. Caution: estimate the growth in GRAT assets to avoid exceeding the $2 million GST exclusion at the end.

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