We often think of gifting as the simple act of giving an asset with a value to a loved one. Many individuals with wealth make annual gifts and have a long-term strategy to maximize these types of simple gifts. More complicated gifting strategies are often not considered. One strategy that should be explored are Grantor Retained Annuity Trusts (GRATs).
For tax professionals and estate planners, GRATs are exciting and our eyes may even light up discussing GRATs, while our clients try not to fall asleep. The goal of this blog is to introduce the strategy, without boring you because the fact is a consistent gifting strategy using GRATs can be a very powerful wealth transfer tool.
The general idea behind a GRAT is to transfer appreciation of an asset (not the asset) to a beneficiary at a low gift tax cost.
The first step is identifying assets to use in GRAT. The most common asset we see used is a concentrated position in a publically traded security. We want the potential for significant appreciation, so a concentrated position has potential to make large upward moves. Yes, they can go down, but in the GRAT strategy, there is no tax risk if the asset decreases in value. Securities that generally move in the same direction like a specific sector are also good candidates for a GRAT. We don’t want to use a diversified bucket of securities that dampens the upside and limits the downside.
After choosing the assets to use an irrevocable trust is created to hold the assets. This trust has four parties:
- The Grantor (person making the gift to the trust).
- The Trustee – generally the grantor.
- The current beneficiary of the annuity – the grantor.
- The remainder beneficiary – the person the recipient of the appreciation.
The trust requires the trustee to pay to the current beneficiary (the grantor) an annual payment.
The gift from the grantor to the remainder beneficiary is the expected value in the trust in excess of the annuity payments. If the expected value of the trust is $5,000,000 and the current value of the annuity payments are $4,999,650 the gift will be $350. Although the numbers are made up, having a gift value of less than $1,000 is not abnormal.
GRATs check many boxes on the wish list:
- The grantor retains the principal for future use or cash flow needs.
- The beneficiary may receive significant value.
- It is a short-term strategy, often GRATs have 2 year terms.
- It is very tax efficient.
The downside is this is not a strategy you can execute on your own. You will need to work with your estate-planning attorney to draft and execute this strategy.
For taxpayers that have a taxable estate, the savings can be huge. The $430,000 of value transfer will save a little less than $172,000 in estate tax on this gift alone. If the Biden tax plan gets passed, this strategy becomes even more powerful.
Origin CPA Group is dedicated to proactive, consistent communication with our clients. This proactive approach allows our advisors to be forward looking, not stuck in the rear view mirror. The GRAT strategy is an example of how integrated proactive planning can save significant tax dollars. Most of all, we provide Peace of Mind for our clients with our proactive approach to tax advising.
To learn more about this topic contact Origin CPA Group today.