A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust designed to transfer future asset appreciation to family members with potentially reduced gift and estate tax exposure.
In a GRAT, assets are transferred into the trust for a set period of time, usually 2 – 3 years, while the grantor receives fixed annuity payments back from the trust during the term. If the assets inside the GRAT appreciate faster than the IRS assumed growth rate used when the trust is created (currently 5%), the excess appreciation will ultimately pass to beneficiaries outside of the taxable estate without using any gift tax exemption (“zeroed out GRAT”).
GRATs are most used with assets expected to appreciate significantly over time, including private business interests, concentrated stock positions, or other high-growth investments.
Types of Grantor Retained Annuity Trusts
Rolling GRATS
A rolling GRAT strategy uses a series of shorter-term GRATs established over time, often with one new GRAT created each year. By creating multiple GRATs rather than relying on a single long-term trust, the strategy can capture appreciation in successive periods and reduce the risk that poor performance in one period offsets stronger performance in another.
GRAT Case Study
After spending nearly two decades building her software company, Jennifer began thinking more seriously about how future appreciation in the business could affect her long-term estate plan. Much of her wealth was tied to company shares that were expected to continue growing, and her estate planning team wanted to explore ways to transfer some of that future appreciation more efficiently.
Jennifer established a three-year GRAT funded with $10 million of company shares. Because the GRAT was structured as a zeroed-out GRAT, she did not use any lifetime gift tax exemption when the trust was created. Over the following three years, the company continued growing faster than the 5% IRS hurdle rate used when the GRAT was established, while Jennifer received annuity payments from the trust totaling approximately $11.1 million.
By the end of the GRAT term, roughly $1.8 million of excess appreciation passed into trusts for her children outside of her taxable estate. As the company continued expanding, Jennifer later established additional GRATs using the same general approach as part of her broader estate planning strategy.
Summary
Jennifer used a GRAT to begin transferring future appreciation in her business to the next generation while still maintaining liquidity during the trust term. As the company continued growing, the GRAT became part of a broader long-term estate planning strategy focused on reducing future estate tax exposure.
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GRAT FAQs
Is a GRAT revocable?
No. A GRAT is an irrevocable trust, meaning the structure generally cannot be changed once established.
What types of assets are commonly used in GRATs?
GRATs are often funded with assets expected to appreciate significantly, including private business interests, concentrated stock positions, or other high-growth investments.
Why are GRATs often used with appreciating assets?
The strategy is designed to transfer growth above the IRS assumed growth rate. If the assets appreciate faster than that rate during the trust term, the excess value will pass to beneficiaries with no transfer tax.
What happens if the assets do not outperform the IRS hurdle rate?
If the assets in a GRAT do not appreciate above the IRS assumed growth rate during the trust term, the GRAT produces no remainder for the beneficiaries. In that case, the grantor receives the contributed value back through the scheduled annuity payments and is in the same economic position as if she had not set up the GRAT to begin with. The returned assets can then be used to create a new GRAT, allowing the family to continue the strategy and capture future appreciation cycles.
What happens if the grantor dies during the GRAT term?
If the grantor dies during the GRAT term, the GRAT assets are included in the grantor’s taxable estate for estate tax purposes. This eliminates the intended transfer-tax benefit of that GRAT, but it does not leave the grantor’s estate worse off than if the GRAT had never been created. The assets are simply taxed in the grantor’s estate as they would have been if the grantor had continued to own them outright.
Why do some families establish rolling GRATs?
Rolling GRATs allow families to create repeated opportunities to transfer appreciation above the IRS hurdle rate. Each GRAT is a separate attempt to capture a favorable appreciation cycle. If a particular GRAT succeeds, the excess growth passes to family members with no taxable gift. If it does not succeed, the annuity payments return the assets to the grantor, leaving her in the same economic position as if that GRAT had not been created. By using a series of GRATs over time, the family can capture strong market cycles while unsuccessful cycles do not create downside.
Are GRATs only used by ultra-high-net-worth families?
No. GRATs are often associated with ultra-high-net-worth planning, but they can be useful for a much broader group of clients. A GRAT may be worth considering whenever a client owns assets with strong appreciation potential and wants to transfer future growth to family members without using gift tax exemption.
