What to Look For
High net worth individuals who are willing to make an irrevocable gift to a trust for the benefit of family members, but still seek to maintain an income stream, should consider a Grantor Retained Annuity Trust (GRAT).
A GRAT is a useful strategy to shift wealth from one generation to the next with little or no gift tax. A GRAT allows the grantor to retain some interest income for a period of time, and then ultimately transfer assets to children with the potential for no gift tax.
An individual can set up an irrevocable trust for the benefit of family members and transfer assets to the trust. As a condition of the transfer, the donor receives annual annuity payments for a period of years. The theory behind the GRAT is that the structured payment stream is equal to the value of the transferred property, plus an appropriate rate of interest for the specified term, so that the present value of the gift is zero at the date of the gift. Because the present value of the gift is zero, there is no gift tax on the transfer.
It’s worth noting that not all of an individual’s assets are appropriate for GRAT treatment. A portion of the assets (i.e., the annuity payment) must be distributed to the grantor on each anniversary of the GRAT, so the assets should produce enough cash flow in the GRAT to fund the payment stream. Donors should look to use a mix of income producing assets, coupled with assets that will appreciate in value beyond the rate of return built into the annuity payment, leaving assets in the trust at the end of the annuity term.
The amount of the gift value is minimized because of the annuity payment (i.e., retained interest). If this is structured properly, it will not result in a current gift. Additionally, the income of the GRAT is taxed to the donor, so there are additional estate savings because the trust assets aren’t depleted for taxes. Note that the trust assets can remain in the trust beyond the annuity term. Should the donor die before the end of the trust term, however, the assets would be included in the donor’s estate.
There are many other meaningful ways to stretch your dollar in our new e-book: 12 (More) Great Ideas. Do you have a question about how this information applies to you? Email Jim Sacher, CPA or call him at 440-449-6800.