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Simple English definitions for legal terms
grantor-retained annuity trust
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A quick definition of grantor-retained annuity trust:
A Grantor-Retained Annuity Trust (GRAT) is a type of trust that helps people reduce taxes on their estate. The person creating the trust (called the grantor) puts assets into the trust for a certain amount of time and pays taxes at the beginning. The grantor then receives a fixed amount of money each year from the trust, based on the value of the assets. When the trust ends, the assets go to the beneficiaries without any taxes. There are some rules that must be followed, like making sure the trust earns enough interest and that it cannot be changed once it is created.
A more thorough explanation:
A Grantor-Retained Annuity Trust (GRAT) is a type of trust that individuals can set up to reduce taxes on their estate. It is an irrevocable trust that pays the grantor a non-variable sum as annuity payments based on the fair market value of the trust assets, according to a rate set by the Internal Revenue Service (IRS) regulations. The trust is for a limited period of time, and at the end of its lifetime, the assets are passed to the beneficiaries without estate or gift taxes.
For example, let's say John sets up a GRAT and funds it with $1 million worth of stocks. The IRS sets the annuity rate at 5%, so John receives $50,000 per year for the trust's lifetime. After 10 years, the trust ends, and the remaining assets are passed to John's children without any estate or gift taxes.
GRATs have a few unique elements to them. First, the trust must earn interest equal to or higher than the rate set by the IRS. If the interest rate is lower or the grantor dies before the trust ends, the trust will be closed with the assets going to the estate, not the beneficiaries. Second, the trust must be irrevocable in order to receive the tax benefits of a GRAT. Lastly, the grantor may exchange similar investments with the trust to make sure that the trust makes the required amount of interest every year.