Sen. Bernie Sanders brought the worlds of health insurance, annuities and advanced estate planning together last week when he put together a list of ideas for paying for a shift toward a single-payer health insurance system.
Few observers expect to see Sanders get his single-payer health insurance system bill, S. 1804, signed into law. The list of financing ideas is not even part of the current text of the bill.
But Sanders, an independent from Vermont who teams up with the Democrats in the Senate, did shine a spotlight on what has been a powerful estate planning technique: the grantor-retained annuity trust.
Sanders proposed changing the rules governing GRATs “and other types of trusts and valuation techniques,” citing reports that billionaires have used GRATs and similar techniques to save about $100 billion in taxes since 2000.
Life insurance agents and other financial professionals with few high-net-worth clients may have wondered what the reference to GRATs was all about, and whether that had anything to do with them.
Now that Sanders has included the idea of changing the GRAT rules in such a high-profile financing idea document, it might play a more prominent role in conversations about changing the tax code.
Here’s a look at answers to five basic GRAT questions financial professionals need to understand to talk about the topic.
1. So, what exactly is a GRAT?
A GRAT is a vehicle an individual, or grantor, can use to transfer property.
The grantor creates an irrevocable trust. The grantor then puts property into the trust, for a specified period of time, in exchange for getting fixed payments, every year or more often, from the trust. The value of the fixed payments is based on the fair market value of the property put in the trust.
If the trust period expires before the grantor dies, any value still in the trust goes to the trust beneficiary. The Internal Revenue Service treats the value that goes to the beneficiary as a gift.
In the trust period expires after the grantor dies, then the GRAT assets become part of the grantor’s estate.
A grantor who uses a GRAT may be able to avoid having to pay estate taxes or gift taxes on the appreciated value of the property transferred into the GRAT.
The value of the tax break a GRAT can provide depends on the level of the official interest rate used to value the grantor’s retained interest. The lower the official rate used in the valuations, the more successful the GRAT will be.
(Related: The Clock Is Ticking on GRATs)
A shorter trust term also helps increase the odds that the GRAT will succeed in lowering overall taxes.