Grantor Annuity Trusts Remain Viable

Recently proposed legislation would have severely reduced the tax benefits of the grantor annuity trust (GRAT). However, this popular estate planning technique has dodged the cutting block, at least for the time being. As a result, now is a good time to review your options.

GRATs, which are irrevocable trusts, are typically funded with income-producing property such as company stock or real estate. The trust pays you annual income for a set period of time that may be only a few years. When the term expires, the assets that remain in the trust go to beneficiaries you have designated—perhaps your children or grandchildren.

The IRS treats the transfer of those remaining assets as a potentially taxable gift—but it determines the value of that gift when the trust is set up, not when its term expires. To calculate the remainder, you take into account two factors: how much the trust assets would increase if they grew at a specified IRS interest rate; and how much they will be reduced by the annuity payments to you. For this calculation, you use the “Section 7520” rate in effect when the trust is established. (The rate is adjusted up or down each month to reflect prevailing interest rate conditions.)

With current rates quite low—the Section 7520 rate in May 2017 was only 2.4%, compared with 6.2% on August 2007—this can be a good time to transfer property to a GRAT. If the actual appreciation of the trust assets exceeds the specified rate, you and your beneficiaries come out ahead, because that additional amount won't be taxed.

Suppose you transfer $1 million in company stock to a GRAT with a three-year term. You can structure the trust so that the payouts to you exactly equal the hypothetical value of the assets if they grow at the Section 7520 rate. Such a GRAT is said to be “zeroed out”—because the remainder, and thus your tax liability, is projected to be zero.

If you die before the trust expires, the property remaining in the trust reverts to your taxable estate. That defeats one purpose of establishing a GRAT—to reduce the value of your estate—and the shorter the term of the GRAT, the better the likelihood that you’ll outlive it. But under the bill that passed the House of Representatives, a GRAT would be required to last at least 10 years, and you would no longer be allowed to zero out the trust.

Currently, the GRAT remains a valuable estate planning tool for some families. But proposals restricting the benefits resurface in Congress in the future. We can work with you and your attorney to determine the right move in your situation.

This article was written by a professional financial journalist for G.W. Sherwold and is not intended as legal or investment advice.

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