Can a GRAT Help Me Pass More Wealth to My Heirs?


Grantor retained annuity trusts (GRATs) became popular after a 2000 ruling of the U.S. Tax Court in favor of the Walton family (Audrey J. Walton V. Commissioner of Internal Revenue), which upheld the family’s use of two such trusts to avoid the gift tax. GRATS are now frequently used in estate planning for wealthy individuals who wish to make sizable financial gifts to family members. To determine whether a GRAT could benefit your family, you need to understand how the gift and estate taxes work and how a grantor retained annuity trust can help avoid them.


How do gift and estate taxes work?

Gift Tax, Annual Exclusion, and Lifetime Exemption

The gift tax applies to certain gifts made to others during one’s lifetime, and the estate tax applies to wealth transfers after one’s death. The gift tax was originally enacted in the 1920s to prevent individuals from avoiding federal estate taxes by transferring wealth before they die. It currently applies to most gifts (with some exceptions) of over $15,000 per year to any individual. A gift of more than $15,000 to an individual must be reported to the IRS, with the amount above the $15,000 threshold subject to gift tax, which can range from 18% to 40%, depending on the amount taxed.

Making a gift of more than $15,000 to someone doesn’t necessarily mean you have to pay the gift tax, however. Instead, you could apply the amount in excess of the $15,000 annual exclusion to your lifetime gift tax exemption. As a result of the 2017 Tax Cuts and Jobs Act, this exemption has been over $11 million since 2018 ($11.7 million for 2021), more than double its 2017 level. This bump was temporary, however, and is set to return to its previous level of $5.49 million in 2025.

Estate Tax Exemption

The federal estate tax applies to assets passed on after death that exceed the estate tax exemption, which is the same as the lifetime gift tax exemption. Together, they are referred to as the unified tax credit. Treating the gift and estate tax exemptions as a unified credit results in an overarching tax policy that covers gifts from living individuals as well as transfers from their estates after death.

For example, say that you give your child $100,000 for a down payment on their first home. Instead of paying gift tax on the $85,000 above the annual exclusion, you can apply this to your lifetime exemption limit and avoid immediate tax consequences.

If the sum of your taxable gifts and assets passed on through your estate are less than the unified credit, then none of it will be subject to gift or federal estate tax.

How can a GRAT help avoid these taxes?

A GRAT is an irrevocable annuity trust that exists for a specified number of years. The grantor funds it with appreciable assets (such as shares of stock or other investments) and receives income from the annuity for the specified period. The expected rate of return is specified by the IRS (known as the 7520 interest rate). If, after distributing the full stream of income, the annuity still holds assets at the end of its term, this remaining balance could be distributed to heirs free of federal tax.

This is because for the purposes of the gift tax, the grantor makes the gift at the time they establish the GRAT. When the IRS determines the value of this gift, they take the initial contribution and expected rate of return into account. In what has become known as a “Walton GRAT,” the income stream is designed to reduce the value of the gift portion of the GRAT to zero, making any remaining funds exempt from gift tax.

Historically low interest rates make GRATS more appealing.

Since the pandemic hit global markets in March of 2020, the 7520 interest rate has been at historic lows. As a result, there is currently a great deal of potential to pass on gains from appreciated assets via GRATs while avoiding gift and federal estate tax consequences. This can be particularly useful for executives and employees with pre-IPO shares in their companies, which could appreciate considerably over the term of a GRAT.

Are there drawbacks to GRATs?

When considering a GRAT, it’s important to work with financial professionals who are experienced in tax and estate planning. They can help ensure that you understand all legal and tax details of the trust and that it’s designed to meet your goals. Potential drawbacks include

  • Taxability: As the owner of the trust, you will need to pay income tax on its earnings.
  • Irrevocability: Once you establish a GRAT, you can’t change it without getting permission from its beneficiaries.
  • Uncertainty: This strategy only works if the grantor survives the term of the GRAT. If you establish a GRAT and die before its term is up, the trust’s remaining assets become part of your estate.

The experienced wealth managers at WRP provide comprehensive financial and tax planning and investment advice. For more insights on financial planning and wealth management, browse our blog!


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