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Estate Planning with Grantor Retained Annuity Trust

09.17.20 written by

During this crazy 2020 tax year, in addition to being faced with all the issues surrounding Covid-19, as well as the roller coaster ride of the stock market, we are currently also in an environment where the interest rates are as low as they ever have been. As a result of those low-interest rates, some individuals who may have a federal estate tax problem are looking for various estate planning ideas to reduce that estate tax that their loved ones would have to pay upon their passing. One such estate planning technique is called a Grantor Retained Annuity Trust or GRAT for short.

A GRAT is an estate planning technique whereby an individual creates an irrevocable trust and transfers assets to that irrevocable trust in order to benefit his or her children or other beneficiaries and in return retains an annuity interest for a number of years. For example, let’s say an individual owns stock of a closely held business worth $800,000 and sets up a ten-year GRAT.  In this type of planning technique, that individual would transfer preferably non-voting stock in the closely held business to the GRAT in exchange for the GRAT paying an annuity amount to the individual who established the GRAT for ten years. The annuity amount payment means that the GRAT to pay back to the individual a percentage of the amount of the initial assets that were contributed to GRAT over those ten years.  If the percentage is a straight ten percent payout each year then the amount paid back each year would be approximately $80,000. At the conclusion of the five-year period, the grantor will have received an amount back equal to the entire amount of his or her initial transfer of assets to the GRAT ($800,000), plus an interest component which is currently approximately 1%. 

At the end of the GRAT term of ten years, the stock will transfer to the individual’s children.  If the GRAT has grown greater than 1%, then the additional amount of growth is also transferred to the children as well. The GRAT makes the annuity payment with the distribution of earnings it receives from the closely held business which is presumably an S Corp or a limited liability company taxed as a partnership. Assuming that the distribution received is greater than the annuity payment, the GRAT uses cash assets to make the annuity payment. In order for the planning to work, the closely held business must be able to make enough distributions to the GRAT for the GRAT to make the annuity payment or else the GRAT has to return some stock to the individual who established the GRAT.  Also if the individual dies before the term ends, the entire amount of assets are includable in the individual’s estate and the technique will have failed.  If the planning works, the stock and all of the growth on the stock are out of the individual’s estate and the individual’s family will save as much as 40% of the value of the stock or $320,000 in the example above.

This transaction can be structured so that there is no gift tax consequence to the individual establishing the GRAT.  If an individual is in a situation where there is a concern about estate taxes or the possibility of estate taxes when the federal estate tax exemption is reduced due to a change in the presidency, or congress, or in 2026 since it is scheduled to go back from $11.58 million to the 5 to 6 million dollar range, then the individual should seriously consider using a GRAT.  Please see your local estate planning attorney for more details.

 NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.

James F. Contini II, Esq.
Certified Specialist in Estate Planning,
Trust & Probate Law by the OSBA
Krugliak, Wilkins, Griffiths & Dougherty Co., L.P.A.
405 Chauncey Avenue NW
New Philadelphia, Ohio 44663
Phone: 330-364-3472
Fax:  330-602-3187