1. What is a grantor retained annuity trust (“GRAT”)?
A GRAT is an estate planning technique that allows someone to make large financial gifts to family members, retain an income stream from the trust, and avoid the U.S. gift tax.
2. How does a GRAT work?
To begin with, the creator/grantor of the trust makes an irrevocable gift to a trust and, at the same time, keeps an annuity interest that provides the grantor with an income stream for either a set number of years or for life, whichever ends first. The beneficiary of the trust holds a remainder interest in the trust asset(s) that passes to him or her at the expiration of the trust term. If the grant or dies before the expiration of the term, however, the value of that remainder interest is calculated into the grantor’s taxable estate.
3. How does a GRAT avoid the gift tax?
The GRAT is premised on the idea that the assets transferred into the trust will appreciate in value faster than the interest rate measured by the IRS in section 7520 of the Internal Revenue Code. If the assets of dual, in fact, appreciate at a rate greater than that which is listed in 7520, that increase in value (above the 7520 rate) is transferred to the beneficiaries free of the gift tax.
4. What is the most important aspect of creating a GRAT?
When creating a GRAT you must be certain that the irrevocable trust meets the requirements of IRC section 2702.