The idea behind a Grantor Retained Annuity Trust (GRAT) is simple…
A wealthy individual transfers assets into a trust. The trust then makes
annual payments back to the individual over a term of years. In theory,
the annuity payments back to the individual consume the assets that were
originally transferred into the trust. Whatever is left over at the end
of the term is transferred to the beneficiaries of the trust.
In a low interest rate environment (such as now), the IRS assumes that
the assets within the trust will also grow at a low rate (called the 7520
rate). In 1989, the 7520 rate was approximately 10%. Currently, the 7520
rate is about 2%. If the assets in the trust grow faster than the 7520
rate, assets are transferred to the trust beneficiaries tax-free.
So here is a typical scenario:
A wealthy individual transfers assets into a GRAT. The annuity payments
are set up so that at the end of the trust term, the initial assets are
completely consumed (this is called a “zeroed out GRAT”).
The annuity payments are calculated using the IRS 7520 rate. From an IRS
standpoint, the individual has not made any gifts to the trust beneficiaries
because the value of the GRAT is zero at the end of the term.
The individual knows, however, that the assets will greatly appreciate
over the term of the GRAT. For example, the asset could be a company that
will go public in the next few years. Another example would be an oil
or gas well that is about to significantly increase production. If the
asset appreciates in excess of the 7520 rate, the annuity payments will
not completely consume the assets. The amount remaining in the GRAT at
the end of the term is transferred to the trust beneficiaries tax free.
According to Bloomberg, the following executives have used this technique:
• GE (GE) Chief Executive Officer Jeffrey Immelt
• Nike (NKE) CEO Philip Knight
• Morgan Stanley (MS) CEO James Gorman
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