The GRAT (Grantor Retained Annuity Trust)
It may seem counterintuitive to consider wealth transfer opportunities as financial markets continue to experience volatility with the spread of coronavirus across the globe. However, 2020 will likely prove to be a historically unique time to leverage tax planning strategies, particularly if the financial impacts of the coronavirus prove to be relatively short-term.
One opportunistic strategy is the Grantor Retained Annuity Trust (or “GRAT”). In basic terms, a GRAT is a trust that receives a gift of assets and repays to the transferor a yearly amount (hence the “annuity”). A GRAT is well suited for both those individuals who have estate tax exemption remaining or those who have exhausted all of their lifetime exemption, as a GRAT can be structured to result in no taxable gift (a “Zeroed-Out GRAT”). It’s also an excellent strategy when gifting hard-to-value assets like closely held business interests.
Why employ a GRAT today? In basic terms, to place the anticipated recovery in asset prices outside of your taxable estate at little or no gift tax cost today.
A GRAT “works” when the combined income and appreciation in the assets of the GRAT exceeds the “hurdle rate” (1.2% per annum for April 2020) over the term of the GRAT. The Federal Reserve’s recent interest rate cuts also reduced the hurdle rate for GRATs (at 1.2%, this is the lowest since 2013). Low interest rates combined with artificially decreased valuations for marketable securities and closely held business interests make this an ideal time to consider a GRAT.
For example, assume that a Zeroed-Out GRAT was funded with shares of an ETF that tracked the S&P 500 while the S&P 500 is at 2,300 (roughly the level as of the time this article was written). Assume that over the next 12 months the S&P 500 recovers to 3,000. The 700-point increase would be owned by the GRAT, effectively transferring the bulk of that 30% recovery to the next generation without using any of the individual’s estate tax credit. This strategy can be effective even if financial markets do not regain their all-time highs in the near future.
Wealth transfer strategies are not “one size fits all.” Many individuals will be rightfully cautious, given the recent turmoil in financial markets. However, we are nonetheless presented with a unique chance to lock in potential estate tax savings against a future that will likely include higher tax rates. Action now will lock in savings that may well evaporate.
Some tax savings strategies allow you to also provide for a “rainy day fund” in the event circumstances change. One such strategy is a Spousal Lifetime Access Trust (“SLAT”), which will be explored further in an upcoming article.
Finally, do not overlook the importance of core estate planning documents such as Wills, Revocable Trusts, Powers of Attorney and Advanced Health Care Directives. Every estate plan should be reviewed from time to time to make sure it continues to address each individual’s needs and objectives as well as to take advantage of developments in the law.
If you would like to review your estate plan or explore potential wealth transfer opportunities, please contact us at your convenience.
- Larry S. Blair, Esq. | 412-918-1123 | lblair@metzlewis.com
- Nicholas J. Holland, Esq. | 412-918-1143 | nholland@metzlewis.com
- Steven H. Seel, Esq. | 412-918-1125 | sseel@metzlewis.com
This post was written by Nicholas Holland and Steven Seel
