Estate planning in the 21st century is often a complicated and involved process that encompasses a wide of strategies and tools. Like many people, you may decide to include at least one trust in your comprehensive estate plan. For example, you may decide that a Grantor Retained Annuity Trust, or GRAT, is right for your estate plan. Only an experienced Missouri estate planning attorney can evaluate your unique needs and circumstances; however, a basic understanding of what a GRAT is and why you might wish to create one may be beneficial as well.
Often used as a tax avoidance tool, a Grantor Retained Annuity Trust, or GRAT, is a trust that allows you to transfer assets at a severely reduced tax rate. The trust is typically a short-term trust that directs annuity payments from the interest earned on trust assets to be paid to you during the life of the trust. At the end of the term, the remaining assets left in the trust are released to the beneficiary of the trust tax-free.
GRATs have long been controversial because detractors see a GRAT as a legal way to transfer wealth without paying taxes. Efforts to eliminate the final tax-free payment as well as extend the minimum time a GRAT was remain in effect have so far been unsuccessful. The strategy of making the remaining assets part of the final payment is called zeroing out. Because of the controversy surrounding GRATS, you should not attempt to set up a GRAT without the help of an estate-planning attorney who knows what has been happening with regard to the proposed changes.
Despite the controversy, GRATs are completely legal and are convenient ways to make intergenerational transfers that might otherwise be subject to high taxes. The way a GRAT works is that the grantor sets up the trust and transfers assets into the trust with provisions for a retained “annuity” payment. An IRS determined interest rate applies to the annuity payments; however, the interest rate is typically very low. The key, therefore, to the success of a GRAT is that the assets held by the trust need to appreciate at a rate higher than the interest rate established for the annuity payments – a feat that is not usually difficult to accomplish. The interest that is retained after the annuity payments is then transferred to a beneficiary at the end of the trust term tax-free. The math isn’t hard to calculate. Imagine putting $10 million into a trust that appreciates at the rate of 7.4 percent per year – not an unrealistic rate of return with skilled trust administration.
Assume further that the IRS prescribed 7520 rate (the required annuity interest rate) is at 2.4 percent. The trust will net $500,000 in tax-free interest in the first year alone.
The only real risk to a GRAT is the death of the grantor. Everything in the trust immediately becomes part of the estate of the grantor after his or her death — the beneficiary of the trust receives nothing other than what he or she is supposed to get from the estate – and becomes subject to gift and estate taxes. However, the assets would have been part of the taxable estate anyway had the trust never been set up.
If you have additional questions regarding a GRAT, or wish to set one up, contact the experienced Illinois estate planning attorneys at Nash Bean Ford & Brown, LLP by calling 309-944-2188 to schedule your appointment today.
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