RANTOR RETAINED ANNUITY TRUST

A GRAT is a trust with a specific life or term. They allow the grantor to move substantial assets out of their estate, while retaining an income stream from those assets for a period of time. If the grantor outlives the term of the trust, the assets pass to the trust beneficiary(ies) at a discount for gift and estate tax purposes.

Process
The grantor transfers income producing property to the GRAT and retains an income interest in the trust. This income interest takes the form of an annuity. Each year the GRAT will distribute to the grantor the required
payment. At the end of the GRAT term, any remaining assets will be distributed to the named beneficiary(ies). When assets are initially transferred to the GRAT, the transfer is considered to be a gift to the trust beneficiaries. The value of the gift is reduced by the “annuity payments”. This value is determined by a number of factors, including the length of the term of the trust, the amount of the annuity payments and the applicable federal rate (AFR) of interest at the time the assets were transferred. Because the gift to the GRAT is of a future interest, it does not qualify for the annual gift tax exclusion. However, the gift can be sheltered using the grantor’s lifetime gift tax exclusion.

LIFE INSURANCE CAN BE USED AS A HEDGE AGAINST THE GRANTOR’S UNTIMELY DEATH. IF AN INSURED GRANTOR SURVIVES, THE TRUST ASSETS WILL BE EXCLUDED FROM THEIR ESTATE, AND THE INSURANCE PROCEEDS CAN PROVIDE LIQUIDITY TO PAY SETTLEMENT COSTS INCURRED BY THE GRANTOR’S OTHER ASSETS.

Example
Don, age 60, transfers appreciating stock with a fair market value of $1,000,000 to a GRAT with a 8% payout and a term of 10 years. Don will receive 10 annuity payments of $80,000 per year. Assuming an AFR of 5%, the present value of Don’s income stream is $575,736. Therefore, the amount of the gift to the beneficiaries is reduced to $424,264. Note: the greater the value of the annuity payments, the lower the amount of the initial gift.

Consideration – Mortality Planning
For a GRAT to achieve its full potential, the grantor must outlive the term of the trust. If the grantor survives the trust period, none of the trust assets will be included in their estate and the remaining trust will be paid to the beneficiary(ies).

If the grantor dies during the trust period, all or a portion of the assets in the GRAT will be includable in the grantor’s gross estate for estate tax purposes. Therefore, the grantor’s health and life expectancy should be
evaluated when selecting the trust period. Keep in mind, other than the transaction costs of establishing and administering the GRAT, the Grantor is no worse off than if the GRAT was never established should he or she die prior to the end of the trust term.

Consideration – Life Insurance
Life insurance can be used as a hedge against the grantor’s untimely death. If an insured grantor survives, the trust assets will be excluded from their estate, and the insurance proceeds can provide liquidity to pay settlement costs incurred by the grantor’s other assets.