In a low interest rate environment, a grantor retained annuity trust (GRAT) can serve as a powerful estate planning tool to allow your high-net-worth clients to transfer assets with minimal — and, in some cases, zero — tax liability.
Clients with swiftly appreciating assets can transfer these assets and escape both gift and estate taxation on almost all of the appreciation using a combination GRAT–life insurance strategy in connection with the steep gift tax valuation discount available today. Despite this, the Obama administration has often threatened to eliminate the tax benefits that can be realized using a GRAT strategy, so the time for clients to lock in these tax savings is today.
GRATs: The basics
Though the current low interest rate environment may present a problem in many planning scenarios, some planning vehicles actually benefit from low interest rates. One such vehicle is the GRAT, the success of which can actually thrive on low interest rates.
A GRAT is typically established in order to transfer assets while minimizing estate and gift taxes, yet allows the client to continue to receive a steady income stream in the form of an annuity over the life of the trust. When a client creates a GRAT, he retains the right to fixed annual payments for the term of the trust’s life, which is either an established period of time or for the client’s life. The remaining trust assets pass to his beneficiaries at the end of the trust term.
Typically, a GRAT will be funded for a relatively short period of time and with assets that are likely to appreciate in value over that term.
The interest rate factor
The value of the taxable gift to the GRAT beneficiaries is equal to the fair market value of the property transferred into the GRAT minus the grantor’s retained interest. The grantor’s retained interest is the actuarially calculated value of the annuity stream he will retain over the GRAT’s life, based on the Section 7520 rate in effect for the month in which the GRAT is created.
Because a lower Section 7520 rate will increase the present value of the grantor’s retained interest, and the current rate is locked in for the life of the GRAT, a low interest rate will reduce the taxable value of the beneficiary’s gift. For the GRAT to succeed, tax-wise, the assets placed into the trust only need to outperform that locked-in Section 7520 rate.