A Grantor Retained Annuity Trust (GRAT) is created by transferring one or more appreciating assets into an irrevocable trust. The client retains the right to receive a fixed payment or annuity for a specified number of years (term of years) or the shorter of the term of years or the rest of the client’s life. At the end of the term, the remaining assets of the trust, including all appreciation, are distributed to a specified beneficiary or beneficiaries.
The fixed annuity payment is usually expressed as a percentage of the original value of the assets transferred to the trust. For example, if $100,000 is placed in the trust and the annuity payout is specified as six percent, the trust would pay $6,000 a year to the client regardless of the value of the trust assets. If the income earned on the assets doesn’t cover the annuity amount, payments are made from principal. All income and appreciation in excess of what is needed to pay the annual annuity accumulates in the trust for the benefit of the beneficiary (or beneficiaries).
Creation of a GRAT is subject to the Federal gift tax, but the amount of that tax can be managed. The gift tax value of the assets transferred to the trust is determined by subtracting the present value of the annuity from the fair market value of the assets on the date they are transferred to the trust. The value of the annuity interest is determined using actuarial present values tables and the interest rate issued by the IRS on a monthly basis, known as the “7520 rate.” In light of this valuation method, GRATs become much more attractive during period of low interest rates as the “7520 rate” follows prevailing interest rates. It may even be possible to zero out the gift by having the annuity interest be equal to the fair market value of the assets transferred to the GRAT.