What is a Grantor Retained Annuity Trust? Who needs one? Why now?
01/What is a GRAT?
A GRAT, or a Grantor Retained Annuity Trust, is an irrevocable trust used to reduce estate taxes without having to give away all of your assets.
The Grantor transfers appreciable property - such as brokerage, minerals, business interests, real estate - to the GRAT for a specific term (2-10 years). As the name suggests, the GRAT is a trust that pays an annuity back to the grantor over the term of the GRAT. At the end of the term, any assets remaining in the GRAT as well as the growth on the assets that belonged to the GRAT are distributed to the beneficiaries, and no estate taxes will be owed on those assets and growth when the Grantor dies.
The annuity that gets paid back to the Grantor is calculated, in part, based on something called the 7520 rate, an interest rate published monthly by the IRS for these kinds of transactions. In creating the GRAT, the Grantor is betting that the appreciation of the assets inside of the GRAT will outpace the applicable 7520 rate, thus allowing the Grantor to transfer the growth without an estate tax liability.
02/Who needs one?
A GRAT is an advance planning tool that isn't for everyone. Most of us do not have a high enough net worth to benefit from this type of tool, but there are many individuals and families who will.
To determine whether or not you will benefit from a GRAT, it's helpful to know a little about how the lifetime estate tax exemption works. As of 2020, the lifetime estate tax exemption amounts are $11.58 million for an individual and $23.16 million for spouses who elect portability. This means that you will only owe estate taxes at death if your assets exceed $11.58 million (or $23.16 million). Any value above that amount will be taxed at 40%.
BUT... those amounts are subject to a "sunset" scheduled for 2025. At that time, unless Congress acts, the lifetime exemptions will be restored to their previous levels, or effectively cut in half.
That means that individuals with a net worth of $4 million or more, or couples with a net worth of $9 million more, should be thinking about creating a GRAT with a term that lasts at least until 2025. If you get the growth of your current assets out of your taxable state, then you are safer if and when the law sunsets in 2025.
03/Why now?
Three things have come together right now to make this the right time to create a GRAT.
- Depressed Asset Values
- Historically Low 7520 Rates
- Estate Tax 2025 Sunset
Depressed Asset Values
Right now, your appreciable assets are worth less than they have been in a long time. Markets are down, minerals are low, certain business interests are worth less than they might be otherwise. This may not seem great for your portfolio right now, but it's good news if you're creating a GRAT. If you transfer those assets into a GRAT now and their values recuperate relatively quickly, all of that appreciation will happen "outside of" your taxable estate.
Low 7520 Rates
The current 7520 rate is 0.8%. By comparison, the rate was 3.4% in the middle of 2018. What this means, practically, is that the annuity payment that comes back to you each year is not bringing much additional interest with it. With interest rates this low, more of what you have transferred into the GRAT stays in the GRAT and grows in a way that is protected from future tax liabilities.
Estate Tax Sunset
And with the laws set to sunset in 2025, this is the right to create an estate planning tool that gets ahead of that significant reduction in the lifetime exemption amount.
Here's the stuff we always put at the end: If you want to know more, we would love to talk with you. Best part, the conversation about how it could benefit you doesn't cost anything. Call us at (918) 770-8940, send an email to firm@tallgrassestateplanning.com, or click HERE to schedule a free consultation with a Tallgrass attorney.
Disclaimer: Reading this blog post does not create an attorney-client relationship, and it is not formal legal advice. This is for information purposes only. It is always best to speak with an attorney about your questions, assets, concerns, and needs.
