Legal Definitions - GRAT

GRAT stands for Grantor-Retained Annuity Trust.

A Grantor-Retained Annuity Trust (GRAT) is a specialized type of irrevocable trust used primarily for estate planning. When someone creates a GRAT, they (the "grantor") transfer assets into the trust for a specific period of time. During this period, the grantor receives a series of fixed payments, known as an annuity, back from the trust. Once the specified term ends, any assets remaining in the trust, including any appreciation in value beyond what was paid back to the grantor, are then passed on to designated beneficiaries (such as children or grandchildren), often with the goal of reducing potential gift and estate taxes.

Here are some examples to illustrate how a GRAT works:

• Example 1: Passing on a Family Business

  Imagine Sarah, the owner of a successful tech startup, wants to eventually transfer ownership to her children while minimizing future estate taxes. She believes her company's stock will significantly increase in value over the next five years. Sarah decides to create a GRAT, funding it with a substantial block of her company's stock. For the next five years, the GRAT pays Sarah an annual annuity payment. If, after five years, the stock has appreciated significantly beyond the total annuity payments Sarah received, the remaining, highly appreciated stock is then transferred to her children as the trust's beneficiaries. This allows the future growth of the company's value to pass to her children outside of her taxable estate, potentially saving a considerable amount in estate taxes.

• Example 2: Transferring Appreciating Real Estate

  David owns a parcel of undeveloped land in a rapidly growing area that he anticipates will skyrocket in value once a new highway is completed nearby. He wants to ensure this future appreciation benefits his grandchildren. David establishes a GRAT, placing the undeveloped land into it for a term of seven years. During these seven years, David receives annual annuity payments from the trust. If, at the end of the seven-year term, the land has indeed appreciated substantially due to the highway's completion and surrounding development, the land (now worth much more) is then distributed to his grandchildren. The increase in the land's value that occurred within the trust passes to his grandchildren without being subject to additional gift tax, as the initial gift tax calculation was based on the land's value when it was first placed into the GRAT.

• Example 3: Gifting a Diversified Investment Portfolio

  Maria has a diversified investment portfolio that she expects to grow steadily over the next decade. She wants to pass on this wealth to her nieces and nephews. Maria creates a ten-year GRAT, transferring a portion of her investment portfolio into it. For the next ten years, Maria receives a fixed annual payment from the trust. If the investments perform well and grow beyond the total amount of annuity payments Maria received, the excess value remaining in the trust at the end of the ten-year period is then distributed to her nieces and nephews. This strategy allows Maria to "freeze" the value of the gift for tax purposes at the time she created the GRAT, and any subsequent growth above the annuity payments passes to her beneficiaries free of additional gift tax.