A grantor retained annuity trust or GRAT can be a useful estate planning tool if you are exposed to the federal estate tax. Before we explain the value of this type of trust, we should provide some background information about the tax.
Estate Tax Parameters
Every estate is not subject to the estate tax, because there is a credit or exclusion. This is the amount that you can transfer free of the estate tax.
For the rest of the 2014 calendar year, the estate tax exclusion is $5.34 million. Each year the IRS adjusts the exclusion to account for inflation, and they have announced the adjustment for 2015. Next year, the exclusion will be $5.43 million.
We should point out the fact that there is an unlimited marital deduction. You can transfer unlimited assets to your spouse tax-free, so the exclusion would be used to leave tax-free bequests to others.
The top rate of the federal estate tax stands at 40 percent.
In addition to the estate tax, there is also a gift tax, because the tax man doesn’t want you to give gifts while you are living to avoid the estate tax. The two taxes are unified, so the exclusion is a unified exclusion that applies to lifetime gifting along with postmortem asset transfers.
Zeroed Out GRAT
Now that we have provided the necessary background information, we can look at the zeroed out GRAT strategy.
The idea is to fund the trust with highly appreciable assets. When you create the trust, you are called the grantor. As the grantor you take annuity payments throughout the trust term. You also name a beneficiary who would inherit any remainder that may be left in the trust after the term expires.
If there is a remainder, the beneficiary would be receiving a taxable gift. The Internal Revenue Service calculates the value of the gift by adding the hurdle rate to the principal. This accounts for anticipated interest throughout the term of the trust. The hurdle rate is 120 percent of the federal midterm rate.
To zero out the grantor retained annuity trust, you take annuity payments that are equal to the entire taxable value of the trust.
Why would you go through all of this trouble to get all of your own money back? Remember, in the beginning you intentionally funded the trust with assets that you expected to appreciate. The hurdle rate has been relatively low for a number of years. If the assets in the trust outperformed this rate, there will be a remainder left in the trust, even though you took the entire taxable value.
The beneficiary would assume ownership of the remainder free of the gift tax.
Learn More
If you would like to learn more about grantor retained annuity trusts and other estate tax efficiency tools, contact us through this page to set up a free consultation: Bucks County PA Estate Planning Attorneys.
Joe Masiuk, Estate Planning Attorney
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