There are many ways to transfer wealth to family and charitable organizations and many require the outright transfer of assets irrevocably.

In times of economic uncertainty, it can be disconcerting to give away assets that might be needed for personal use down the road. To alleviate this concern, investors may simply prefer to retain a certain amount of principal and feel more comfortable gifting any excess.

A Grantor Retained Annuity Trust (GRAT) is a gifting strategy that may work well in today’s market and interest rate environment. It can also satisfy a grantor’s desire to retain current assets but give away the growth on those investments. GRATs are analogous to investors who prefer to never touch the principal and only spend portfolio income.

To create a GRAT, an investor transfers assets with potential for capital appreciation to a trust for a specified period of time. During the term of the trust, the grantor retains a right to receive an annuity payment equal to the approximate present value of the original gift (original value of the asset plus rate of return specified by the IRS, known as 7520 rate). At the end of the trust term, after all annuity payments have been made to the grantor, any remaining assets are distributed to the beneficiaries (typically the children of the grantor). Simply put, the grantor is giving away any growth on the asset.

There are several key aspects to consider when using GRATs as a wealth transfer and estate planning strategy. These trusts form a split-interest between the grantor (the asset owner) and the beneficiary (or beneficiaries). The IRS requires the use of specific interest rates when calculating the present value of a gift, valuing annuities, etc. The 7520 rate for April 2020 is only 1.2% and it hasn’t been this low since 2013. The 7520 rate is published monthly. The term of the trust is established when the GRAT is created and is typically short-term (about two years). This helps limit the risk of death during the term of the GRAT and provides some comfort to the grantor that assets do not need to be tied up long-term. From an investment perspective, investors usually fund GRATs with assets that have the potential for meaningful capital appreciation like equities. The lower the 7520 rate, the easier it is for underlying equities to outperform.

If you have any questions or request assistance, please
contact a member of the Withum Wealth Management group.

The current environment presents an effective way to transfer the growth in equities to the next generation by using GRATs given the combination of low hurdle rate (1.2%) and 20%+ decline in global equities.

Investor creates a 2-year GRAT and funds it with $1,000,000 of equities in April 2020 with a 1.2% 7520 (hurdle) rate. At the end of years 1 and 2, the grantor receives an annuity payment back equal to the present value of their initial contribution – in this example, the grantor receives approximately $500K back at the end of year one and another $500K at end of year two. Suppose equities perform well and the account earns 20% annually over the two-year period. At the end of the trust term, all investment growth above 1.2% is distributed to the beneficiaries free of estate (and possibly) gift tax. At this point, the GRAT has ended and the grantor can continue to enjoy using the original principal. No further action is required.

Alternatively, rolling GRATs can be used to continue the gifting strategy for as long as the grantor chooses. In this case, rather than the first annuity payment simply be paid back to the grantor, it is used to fund GRAT #2 (can also be a 2-year term). The second annuity payment can then be used to fund GRAT #3 and so on. Investors may choose the rolling GRAT strategy if markets don’t outperform the hurdle rate in a given trust. Using annuity payments to fund new GRATs may help increase the probability of outperformance and successful transfer of growth to the beneficiaries.
The downside of a GRAT is minimal.

  1. Cost of establishing the trust. There are attorney fees involved with establishing the terms of the trust. An attorney who specializes in trusts and estate law is recommended when using GRATs as part of an overall estate plan.
  2. The grantor could die during the term of the GRAT. If the death of the grantor occurs, the transferred assets would be included in the decedent’s estate.
  3. The assets transferred into the GRAT could grow at a rate below the hurdle rate. If assets held in the GRAT fail to outperform section 7520 rate, then the GRAT is unsuccessful from a gifting standpoint – it’s as if the assets underperformed while in the grantor’s name outright.

For further questions and to explore how GRATs can fit into an overall estate plan, please don’t hesitate to contact your Withum Wealth Advisor. An estate attorney is required to execute the legal documents and to provide legal advice.

Withum Wealth Management

Important Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Withum Wealth Management. [“WWM”] ), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article/newsletter serves as the receipt of, or as a substitute for, personalized investment advice from WWM. Please remember to contact WWM in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. WWM is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the WWM current written disclosure statement discussing our advisory services and fees is available for review upon request.

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