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Rethinking clients’ GRAT asset allocations

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It’s a common scenario—a client adopts a carefully chosen planning strategy designed to protect his or her assets based on current (and predicted future) market conditions and, seemingly with a blink of an eye, the winds have shifted and conditions change. The client is left looking for a way out of a potentially irrevocable plan. 

Many clients who established grantor retained annuity trusts (GRATs) are now experiencing seller’s remorse with respect to the assets that have been allocated to these vehicles—especially those clients who funded a GRAT with appreciating stock. While the GRATs themselves are locked in place, there may still be a way out—if the conditions are right, these clients may be able to retrieve and reallocate the stock assets that may be best suited for other uses given today’s market conditions.

The Goal of the GRAT

A GRAT essentially combines a trust that is established for a certain predetermined period of time with an annuity that pays the trust creator (the grantor) a set value each year of the trust’s existence. This annuity payout is the client’s retained interest. The remaining value passes to the client’s beneficiaries, and, thus, out of his or her estate.

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 client’s retained interest.The client’s retained interest is the actuarially calculated value of the annuity stream he or she will retain over the GRAT’s life based on the Section 7520 rate in effect for the month in which the GRAT is created.

The goal is often to structure the GRAT so that the client’s retained interest equals the fair market value of the property at the time it is transferred to the GRAT. This would reduce the gift tax liability to zero, allowing the client to transfer the appreciated value of the assets to his or her beneficiaries gift-tax-free.  The strategy works particularly well in the case of appreciating stock, because it allows the client to “freeze” the value of the stock for transfer tax purposes. Why Replace a GRAT Stock Asset?

Whatever the value of the GRAT strategy, the fact remains that once the GRAT term is established, it generally cannot be changed; market conditions, however, are not so predictable. Many clients have seen stock that’s been transferred into a GRAT appreciate substantially over the past year, and may fear that currently strong equity markets are set to take a dive—making a current sale desirable in order to preserve the appreciated value of the stock.

Fortunately, many GRATs contain a provision that allows the client to replace GRAT assets with a different set of equally valued assets (often consisting of cash, promissory notes or even other appreciable stock). 

Replacing highly appreciated stock in a GRAT with equally valued assets will protect the appreciated value of the stock for the client’s beneficiaries. In the alternative, if the stock value is expected to continue rising, the client can both protect the GRAT value for beneficiaries and retain any further appreciation in value for himself.

Further, for clients who established GRATs to protect themselves against a transfer tax hit brought about by the “fiscal cliff” of January 1, 2013, the gift and estate tax planning goals that motivated them to create the GRAT may no longer exist because of the now-permanent $5 million exemption ($5.43 million in 2015). These clients may wish to remove the stock from the GRAT simply to reclaim control over those assets.


While the reasons for undoing any planning strategy can be as varied as the reasons for creating that strategy in the first place, for many clients, the knowledge that they have options that can help manage changing market—or personal—conditions can prove invaluable.

Originally published on Tax Facts Online,the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.   

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