Grantor Retained Annuity Trusts

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Grantor Retained Annuity Trusts in Reston, VA

Serving Northern VA, DC, and MD

A grantor retained annuity trust (GRAT) is a gifting vehicle that offers a way to shift future appreciation of property to others at a minimal gift tax cost. With this strategy, you would create a trust under which you would retain the right to receive annual annuity payments for a fixed period, such as four years. After the annuity payment period expires, your interest in the trust would terminate, and your children would become the trust beneficiaries.

The success of the GRAT strategy generally will depend on whether the assets transferred to the GRAT have a total annual return during the annuity period more than the IRS assumed rate of return.

For example, assume that when the IRS rate is 5.0%), a client (assume he or she is 40 years old) transferred assets valued at $1,000,000 to a 4-year GRAT that provides for four annual annuity payments to the client, each payment to equal approximately 28.2% of the value of the property initially contributed to the GRAT ($282,000). At the end of the four-year period, the client’s children will become the beneficiaries of the ongoing trust (or outright).

How Does a Grantor Retained Annuity Trust Work?

The tax results are as follows:

  1. Under the Walton case, there should be little or no taxable gift associated with the transfer of assets to the GRAT. The size of the gift may be greater than zero, although still very modest (here, practically $0), and essentially is zeroed out.
  2. Assume that the GRAT actually had an annual investment return of 20%. In the example, there would be approximately $559,800 of value left in the GRAT at the end of the GRAT term for the benefit of the children after the required annuity payments are made to you (or your estate in the event of death).
  3. If there is adverse investment performance and the GRAT has a rate of return of, say, 2% you will receive back all of the trust assets via the annuity payments, and nothing will be left for the benefit of the children. Comparing the favorable result in the preceding paragraph against this downside scenario highlights a key tax benefit of the GRAT — when it works, the results are excellent, and when it doesn’t, the loss is fairly minimal. Based on this characteristic, a GRAT would be an excellent vehicle to hold a highly speculative investment that has the potential for significant appreciation, without any real downside risk.
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