The basic goals of estate planning are to efficiently pass your assets along to your heirs and keep them intact in the process, and estate planning attorneys implement a number of different financial instruments to accomplish these objectives. One of these that can be very effective under certain circumstances is the grantor retained annuity trust, often shortened to the acronym GRAT.
The GRAT accomplishes two different things if it is used successfully: it removes appreciable assets from your estate for estate tax purposes and enables tax-free gift giving. The way that it works is that you fund the trust, which is irrevocable, name your beneficiary, and set the term of the trust. By creating and funding the trust you have reduced the value of your estate, but if you pass away before the term has been completed the assets go back into your estate, so you have to keep this in mind when you are setting the term. During this term you receive annuity payments out of the trust in the amount and frequency of your choosing.
The assets that you placed into the trust will be valuated by the IRS for tax purposes using the Section 7520 Federal Midterm Rate. The taxable amount of the gift will be reduced by your retained interest in the assets in the trust, so if you schedule annuity payments equal to the entire taxable trust value there will be no gift tax due, and this is known as a “zeroed out” grantor retained annuity trust. The Section 7520 rate is update each month by the IRS, so the best time to start a GRAT is when the rate is low. If the assets in the trust wind up appreciating more that that initial valuation by the IRS when the trust was created, all of the remainder will be transferred over to your beneficiary free of the gift tax when the trust has expired.
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