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GRAT - Another Fantastic Way Wealthy Individuals Avoid the Death Tax

By: Jim Dossey, MS, MBA, JD

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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