A Timely Planning Opportunity!
A Grantor Retained Annuity Trust (GRAT) is one of the estate planning techniques based primarily on interest rate assumptions. Clients create GRATs using assets that are likely to earn more than the Internal Revenue Service's measuring standard (the section 7520 interest rate) during the GRAT term in an effort to pass the appreciation in the assets to the beneficiaries free of gift and estate tax.
Each month IRS announces a new 7520 rate. Based on current financial conditions the rate for the month of September is 4.2%. This historically low rate may be headed upwards as interest rates increase. Acting now would lock in this low rate for the term of the trust.
How Does It Work?
A grantor contributes assets to the trust and agrees to receive a fixed dollar annuity payment from the trust each year. Whatever is left in the trust at the end of the term passes to the beneficiaries tax-free. For gift tax purposes the taxable amount of the gift is determined when the GRAT is set up. When setting up the trust a grantor may select the combination of annuity payments and trust term that will result in the present value of all future payments exactly equaling the amount contributed. That way there is no gift tax when setting up the trust.
To calculate the present value of the annuity payments IRS makes the assumption about the rate the assets will appreciate based on the 7520 rate. If the assets appreciate faster than the current 7520 rate of 4.2%, the excess appreciation transfers to the beneficiaries free of estate tax.
Because of closely held business valuation multiples and discounting considerations in determining the current fair value of a minority interest, using stock of an S corporation or limited liability company can be very beneficial in maximizing the value transferred to the beneficiaries. The appreciation potential of the value of a closely held business interest would likely exceed the current 7520 rate of 4.2% by a significant margin.
For Example
If a grantor contributed $5 million to a GRAT and chose a term of 10 years, the annual annuity payment would need to be $622,600 at the current 4.2% rate to zero out the gift for gift tax purposes. If the contributed asset appreciates at 8% during the 10 year term, the asset value remaining in the trust at the end of the term would be $1,775,000.
The grantor receives $6,226,000 over the term of the trust and the beneficiaries receive $1,775,000 at the end of the term without any gift or estate tax liability.
Caution!
While we are not in the business of market timing, the current investment environment makes certain estate planning vehicles particularly attractive. If interest rates increase, the benefits of a GRAT will be greatly reduced. Grantors are well advised to get started today. There are other factors that must be considered so be sure to consult with your financial advisors before implementing this plan.
Contact
Perry Schroeder
, CPA, at (260) 969-2525 or
pschroeder@badencpa.com if you have any questions about this or other estate planning techniques.
