Grantor Retained Annuity Trusts (GRATs): A Possible Estate Planning Tool for Many Ohio Families

By Daniel A. Perry, Esq.

Benjamin Franklin once said that there are two things you can count on in this world, death and taxes. Unfortunately, nothing has changed since Benjamin Franklin uttered this famous phrase. Someday, all of us are going to die. Also, not a year will go by without each one of us having to pay taxes. Nevertheless, even with these guarantees in life, there are many families that have tax considerations when it comes to the transfer of their wealth to the next generation.

Federal Estate Tax

The 2018 exemption adjusted annually for inflation is $11.2 million. This means that a person can pass $11.2 million in assets at death, including life insurance death benefits, with $0 federal estate tax consequences. However, for estates in excess of $11.2 million or $22.4 million for married couples, the federal estate tax rate can rise as high as 40%. Therefore, many families who have estates that may be subject to the federal estate tax are constantly looking for ways to reduce their federal estate tax liability at death.

In recent years, Grantor Retained Annuity Trusts, or GRATs for short, have gained significant popularity. As an overview, a GRAT is a trust that is set up for a pre-determined period of time whereby the grantor (creator of the trust) intends to fund the trust with assets that are expected to appreciate in value. At the conclusion of the life of the trust, the trust assets then pass to the beneficiary with zero or very limited gift tax consequences.

GRAT: A Real-Life Scenario

For example, John and Jane have $25 million in wealth that will pass to the next generation, and therefore, will be subject the federal estate tax. However, John and Jane have an investment asset worth $5 million that is expected to appreciate in value in the amount of $3 million over the next 5 years. Therefore, John and Jane establish a GRAT and fund this GRAT with their $5 million asset. During the next five years, John and Jane receive an annual payment from the GRAT based on the anticipated rate of return. Let’s say John and Jane expect their annual rate of return to be 3%. As such, John and Jane receive a payment out of the trust in the amount of $150,000 per year ($5 million x 3%). At the conclusion of the five-year term, the trust terminates with $5 million returning to John and Jane and the $3 million growth being transferred to their three children. In this scenario, John and Jane have maintained their $25 million estate, created a $150,000 annual payment to themselves from the GRAT, and reduced their taxable estate by $3 million, all the while transferring $3 million in assets to their children tax free.

Let’s say for example that John and Jane decided to do nothing and their estate grew to $28 million. John and Jane both died shortly after. Well, in this circumstance, John and Jane would have an estate of $28 million, whereby $5,600,000 million would be subject to the federal estate tax. This would result in an approximate tax liability for John and Jane’s estate in the amount of $2,585,500.

On the other hand, had John and Jane established a GRAT and reduced their taxable estate to $25 million at the date of their death, then $2.6 million would be subject to the federal estate tax. This would result in an approximate tax liability for John and Jane’s estate in the amount of $1,385,800 million. A tax savings of $1,199,700!

For More Information

These trusts are very complicated, and you should speak with a knowledgeable and experienced estate planning attorney before making the decision whether a GRAT may be appropriate for your family given your unique situation.

If you have questions regarding grantor retained annuity trusts or just estate planning in general, then please contact our office for a complimentary visit so that we can discuss your estate planning needs.

We look forward to hearing from you.