Exploring effective ways to transfer your wealth can be challenging, but a Grantor Retained Annuity Trust (GRAT) provides a clear solution. For high-net-worth individuals, a GRAT can be a valuable tool for efficient wealth transfer and estate and trust tax reduction. In this article, Christopher Kline, J.D., Attorney, explores what a GRAT is, how it works, when a GRAT is most beneficial, and what types of assets make the best candidates for funding it.
What is a Grantor Retained Annuity Trust?
A GRAT is an irrevocable trust designed to minimize gift and estate taxes. The grantor, who creates and funds the trust, transfers assets into the GRAT for a set period. During the term, the grantor receives annual annuity payments from the trust. When the GRAT expires, any remaining assets, typically those with appreciated value, are transferred to beneficiaries with potentially little to no gift tax liability.
One of the primary advantages of a GRAT is how it can help reduce the use of the lifetime gift and estate tax exemption, which is set at $13.99 million for 2025. Instead of depleting this exemption, a GRAT can shift appreciation on assets out of the estate while allowing the grantor to retain the original value of the assets.
How Does a GRAT Work?
When establishing a GRAT, the grantor transfers assets into the trust and retains the right to receive annuity payments for the term of the trust. The IRS sets a “7520 rate,” which determines the assumed rate of return on the assets and is typically used to calculate the value of the annuity payments the grantor will receive. A successful GRAT will have its assets appreciated more than the 7520 rate during the trust’s term. Any appreciation beyond this amount passes to the beneficiaries tax-free.
If the assets do not appreciate, or if the grantor passes away before the term of the trust expires, the remaining assets revert to the grantor’s estate. They may be subject to estate taxes, making the GRAT ineffective in those situations. An experienced estate planning attorney can help you discern how to best structure and fund a GRAT in order to preserve your wealth for years to come.
When Should You Utilize a GRAT?
GRATs are most effective for individuals with significant wealth, especially those who expect their assets to appreciate over time. These are a few examples where a GRAT could be particularly advantageous:
- Reducing Estate Taxes: For individuals whose estates exceed the federal estate tax exemption, GRATs are a way to transfer future growth in asset value to the next generation without incurring significant gift taxes.
- Taking Advantage of Low 7520 Rates: The IRS-set 7520 rate is generally low, and when asset appreciation goes beyond this rate, the remaining value can be passed to beneficiaries tax-free. This makes GRATs especially appealing when interest rates are low, as they allow for greater potential appreciation beyond the IRS’s assumed return.
- Freezing Estate Value: By transferring assets into a GRAT, wealthy individuals can effectively freeze the value of their estate, ensuring any growth in those assets benefits their heirs rather than increasing their estate’s taxable value.
- Passing on Appreciating Assets: If you hold assets expected to appreciate significantly in the near future—such as shares in a pre-IPO company—a GRAT can transfer appreciation to your beneficiaries tax-free.
What Types of Assets Work Well to Fund GRATs?
GRATs are most beneficial when funded with assets expected to appreciate significantly in value over the trust term. Assets which work well for a GRAT include:
- Stocks and Equity in Growth Companies: One of the most famous examples of GRAT success is Facebook founder Mark Zuckerberg, who placed shares of his company’s pre-IPO stock into a GRAT. By the time the stock appreciated after Facebook’s public offering, the value passed to his heirs was far greater than the IRS’s assumed 7520 rate, allowing him to transfer substantial wealth tax-free.
- Startup Equity: If you own stock in a startup likely to see explosive growth, transferring its stock into a GRAT allows you to move future appreciation out of your taxable estate. This can be particularly valuable for startup founders or early investors.
- Real Estate with Growth Potential: Real estate, particularly in high-demand markets, can also be a strong candidate for a GRAT if expected to appreciate significantly over the trust term. By the end of the GRAT’s term, any increase in property value beyond the IRS’s rate can be passed on to beneficiaries tax-free.
However, assets with the potential to depreciate over time are not ideal for a GRAT. If the value of the assets falls below the 7520 rate, the GRAT may not provide any tax benefits, and the assets could return to the taxable estate.
Helping You Get There…
A GRAT is a powerful estate planning tool which can minimize gift and estate taxes, particularly for high-net-worth individuals who expect their assets to appreciate. By locking assets into a trust and receiving annuity payments, a grantor can pass on future appreciation to their heirs with minimal tax implications. A GRAT can be a key component in an effective wealth transfer strategy for those with rapidly appreciating assets or substantial estates. As with all estate planning tools, however, working with a wealth management advisor and estate planning attorney is essential to ensure a GRAT is right for your unique situation. Connect with Boulay’s Estate and Trust team to learn more about how we’re helping you get there.