Legal Definitions - grantor-retained annuity trust

A Grantor-Retained Annuity Trust (GRAT) is a specialized estate planning tool designed to help individuals transfer wealth to beneficiaries, such as children or grandchildren, while potentially reducing gift and estate taxes. Here's how it generally works:

• An individual, known as the "grantor," places assets into an irrevocable trust for a specific, predetermined period (e.g., 5, 10, or 15 years).
• During this trust term, the grantor receives a fixed, regular payment, called an annuity, from the trust. The amount of this annuity is determined at the outset based on the initial value of the assets and an interest rate set by the Internal Revenue Service (IRS).
• If the assets within the GRAT grow at a rate higher than the IRS-mandated interest rate, the "excess" growth remains in the trust.
• Once the specified trust period ends, any assets remaining in the trust (the appreciation beyond the IRS rate, after the grantor's annuity payments have been made) are passed on to the designated beneficiaries without incurring additional gift or estate taxes.
• The primary goal is to "freeze" the value of the assets for estate tax purposes at the time they enter the GRAT, allowing future appreciation to pass to heirs tax-efficiently. However, if the assets do not grow sufficiently, or if the grantor passes away before the trust term ends, the tax benefits may be reduced or eliminated.

Here are some examples to illustrate how a GRAT might be used:

• Example 1: Transferring Shares of a Growing Business

  Imagine Sarah, a successful entrepreneur, owns a significant stake in a rapidly growing tech company. She anticipates the company's value will increase substantially over the next five years and wants to pass this future appreciation to her children without incurring high estate taxes. Sarah could establish a 5-year GRAT, funding it with a portion of her company shares. Each year, she would receive a fixed annuity payment from the trust. If the company's value (and thus the shares within the GRAT) grows more than the IRS-required rate during those five years, the excess value would then pass to her children free of gift or estate taxes at the end of the term. This strategy allows her to transfer the future growth of her business interest to her heirs in a tax-efficient manner.

• Example 2: Gifting Appreciating Real Estate

  Consider David, a real estate investor who owns a commercial property in a developing urban area. He expects the property's value to appreciate significantly over the next decade and wishes to benefit his nieces and nephews. David could create a 10-year GRAT, transferring the commercial building into it. For the next ten years, he would receive a set annuity payment, potentially funded by the property's rental income or other sources. If the building's market value appreciates beyond the IRS hurdle rate, the increased value, after his annuity payments are satisfied, would transfer to his nieces and nephews free of gift or estate taxes when the trust term concludes. This allows David to leverage the anticipated growth of his real estate for his beneficiaries.

• Example 3: Passing on a High-Growth Stock Portfolio

  Maria has a diversified stock portfolio that she believes will experience strong growth over the next seven years. She wants to ensure her grandchildren benefit from this expected appreciation while minimizing the tax burden on her estate. Maria could establish a 7-year GRAT, funding it with a selection of her high-growth stocks. She would receive a fixed annual payment from the trust. If the portfolio's returns exceed the IRS-specified rate, the surplus growth is effectively removed from her taxable estate and passes to her grandchildren without additional gift or estate tax when the GRAT terminates. This strategy is particularly effective when assets are expected to outperform the IRS-mandated growth rate.