Illustrating the Power of a Grantor Retained Annuity Trust

Joseph W. Chase, CFA® BY: Joseph W. Chase, CFA® 12.03.18

Transfer Wealth to Future Generations While Minimizing Tax Impact

When used appropriately, a Grantor Retained Annuity Trust, or GRAT, is a powerful tool by which to transfer wealth to future generations.  

A GRAT is a trust in which the principal is repaid as an annuity to the grantor (the maker of the trust), with interest, typically over multiple years. If the principal grows at a rate higher than the interest rate applied to the annuity payment, the remaining value is transferred to the heirs without triggering a gift tax.  

To illustrate the mechanics of how a GRAT works, the image below outlines what a one-year GRAT would look like, but in reality, these are typically structured to be in place for two or more years.

GRAT Chart

In this example, a husband and wife with $35 million of personal assets transfer $5 million into a GRAT.  The interest rate, based on the 7520 rate, is assumed to be 2% in this case, which means the husband and wife will receive their $5 million, plus 2% interest, back from the GRAT after the end of the GRAT term. 

The investment assets in the GRAT have appreciated by 8% after one year, bringing the total value of the GRAT to $5.4 million. The annuity payment to the husband and wife is $5.1 million ($5 million of principal plus 2% interest), and the remaining $300,000 is transferred to a “Remainder Trust” for the benefit of their heirs.  

The remainder trust is not subject to estate tax, resulting in a potential estate tax savings of $150,000 based on our example above (assuming a 50% combined federal and state estate tax rate).

GRATs are a very effective tool to help you fulfil your goals of creating an enduring family legacy. There are several considerations when choosing to use a GRAT–contact us to learn more about a GRAT and whether this type of trust is right for your personal situation.

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