“Grantor-retained annuity trusts, or ‘Grats,’ are a wealth-transfer technique that shift investment growth out of an estate to heirs tax-free.”
The first thing to know—GRATs are not just for the uber-wealthy, despite the title of the article “Here’s how uber-rich pass wealth to heirs tax-free when markets are down” from CNBC. “Regular” people and their families may benefit from using Grantor Retained Annuity Trusts. The second thing to know–GRATs work well when stocks are down in value and are expected to rebound relatively quickly. While no one knows what the markets will do today or six months from today, GRATs are good estate planning strategy for many people.
The GRAT works like this: assets like stocks in a privately-held business are placed into the trust for a specific amount of time—maybe two, five or ten years. Any investment growth passes to heirs and the original owner gets the principal back. This is, of course, a highly simplified description.
The family can avoid or reduce estate taxes at death by shifting future appreciation out of the estate. The investment growth is the tax-free gift to heirs. If there’s no growth, the asset passes back to the owners. Lowered assets likely to return in value over the life of the trust are the most likely to make this strategy work best.
The S&P 500, a commonly used barometer for U.S. stock markets, is down by about 24% as of this writing, making now an excellent time to consider a GRAT.
The GRAT makes the most sense for families who are subject to the federal estate tax. While the federal estate tax is applied to estates is now valued at more than $12.06 million, the federal estate tax is expected to drop precipitously when the Tax Cuts and Jobs Act of 2017 expires on December 31, 2025.
GRATs are said to have been used by some of the nation’s wealthiest people, including Michael Bloomberg, Mark Zuckerberg, the Walton family (of Walmart fame), Charles Koch and his late brother David Koch, Laurene Powell Jobs (the widow of Apple-founder Steve Jobs), Oprah Winfrey and others. However, a GRAT can work for people who are not among the top wealthiest in the country.
In 2026, the estate-tax threshold will be cut in half, unless Congress extends the Act. Individuals with $6 million estates, or $12 million for married couples, should start considering how to transfer their wealth now.
Rising interest rates put another wrinkle in planning for the future. The complex inner workings of GRATs concern interest rates, which must technically exceed a certain threshold—the “7520 interest rate,” also known as the “hurdle” rate—to pass tax free from the estate. This rate is currently up by 4% from October 2021.
Here’s an example of how this applies to a grantor-retained annuity trust. If investments in a two-year trust grew by 6% over two years, a trust pegged to the hurdle rate of October 2021 would allow 5% of the overall growth pass to heirs, but this would fall to 2% for a trust established in October 2022.
Your estate planning attorney will be able to explain whether a GRAT is a good fit for your wealth strategy, considering your tax liabilities, the size of your estate and your comfort level with any strategies tied to interest rates and markets.
Reference: CNBC (Oct. 10, 2022) “Here’s how uber-rich pass wealth to heirs tax-free when markets are down”