The grantor retained annuity trust, often referred to as a GRAT, has long been a staple of estate planners. However, in the current low-interest-rate environment, with the likelihood of rate increases in the near future, immediate consideration is warranted. This trust allows the creator to give away future appreciation on assets in the trust while retaining the properties’ initial value, plus a fixed return.
A hurdle rate is established and published monthly by the government. If the assets’ growth rate exceeds the hurdle rate, the beneficiaries will receive the excess either outright or in future trust with little or no gift tax cost. The typical assets placed in this kind of trust are closely held or publicly traded stock, real estate holdings or other assets expected to grow rapidly.
An illustration may be helpful. A five-year GRAT is established with assets worth $1 million to minimize gift tax. The hurdle rate at the time of creation is 2.2 percent. Assuming the assets grow at a rate of 8 percent, the results would be as follows:
The required payout to creator over five years is $1,066,962, and the remainder to beneficiaries free of gift tax is $220,674. The underlining assets have grown by $287,636.
Now let’s look at what happens in the same scenario as above, except we establish the trust with interest in an entity worth $1.5 million pre-discounted—but we value the interest transferred with discounts at $1 million.
The required payout to creator over five years is $1,066,962, and the pre discounted remainder to beneficiaries free of gift tax is $952,103. The underlying assets have grown by $519,065.
Hurdle rates have been in the 2 percent range in the recent past, but will move higher as the Federal Reserve pushes interest rates upward. Pre-recession hurdle rates approximated 5 percent, which would cut the benefits in the illustrations above about in half. That said, the present is a good time to reevaluate the advantages of establishing a GRAT or other potential appreciation-shifting techniques with your advisors.
Jack Capron is a principal based out of our Syracuse, NY office.