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GRAT: Strategy In Low Interest Rates Environments

GRAT: Strategy in Low Interest Rates Environments

The past decade has been a historic time for interest rates, as they have hovered around unprecedented lows since the Financial Crisis. These favorable interest rate conditions create some compelling estate planning opportunities. One strategy that is worth a close look is a Grantor Retained Annuity Trust (GRAT), which is a favorable technique to employ in low interest rate environments.

Understanding GRATs

What is a GRAT? This form of irrevocable trust provides an opportunity to move assets out of your taxable estate by engaging in “interest rate arbitrage” with the Internal Revenue Service (IRS). The IRS establishes a threshold for estate planning trusts that depend on prevailing market interest rates. Because the Federal Reserve has lowered interest rates, GRATs are even more attractive as tax-saving and estate-planning vehicles.

With the latest interest rate reduction, the GRAT hurdle rate—called the 7520 rate—has been reduced to 0.6%. This is the lowest it has ever been—even lower than the depths of our post-Financial Crisis stimulus program in 2012. The 7520 rate represents the annual rate of return that the IRS assumes an investor will be able to achieve on his or her assets. If the investments placed within a GRAT outperform the 7520 rate over the GRAT term, the growth beyond that interest rate will be passed on to beneficiaries free of estate tax.

How GRATS Work

The mechanics of the strategy work like this: a GRAT is established with a certain term (typically 2 or 3 years) as part of your estate-planning strategy. Once the account is established, stocks are transferred from the current holder’s name into the GRAT account.

The next step is to calculate an annual annuity payment. Each year, the GRAT will pay the current holder a fixed payment that is calculated using the amount of the assets funding the GRAT, the term of the trust, and the 7520 rate, which is currently 0.6%. The trust is essentially a vehicle that the grantor sets up to pay him or herself annual income. Hence the meaning behind the name- Grantor Retained Annuity Trust. The strategy can be designed so that, at the end of the term, the assets remaining in the GRAT are considered excess growth in the eyes of the IRS. They are then transferred to the beneficiaries—or into an irrevocable trust on their behalf—without impacting the estate tax exemption.

For example, let’s say a couple funded a 2-year GRAT with $1,000,000 in stocks, naming their daughter as the beneficiary. The annuity payments would be slightly larger than $500,000 at the end of the first year and $500,000 at the end of the second year, because the GRAT calculation assumes a 0.6% growth rate. In this example, the annual annuity payment would be about $505,000. The annuity payments transferred from the GRAT back are at the end of each year. During that 2-year period, if the assets appreciate significantly due to good stock market performance, there could be an amount of excess growth remaining in the GRAT after the second annuity payment is made. These excess funds are now officially outside of the estate. The excess growth can be transferred directly to the individual or an irrevocable trust naming her as the beneficiary. The great thing about this strategy is that the transfer doesn’t count as a taxable gift and the estate exemption remains intact.

Benefits of a GRAT

In this extraordinarily low interest rate environment, we believe that GRATs are a great estate planning opportunity for high-net-worth individuals who want to transfer assets to the next generation. With the 7520 rate being as low as 0.6%, there is a higher chance that stocks can beat that rate of return and generate estate tax-free growth.

Since the annuity payments bring the assets back into the grantor’s name, that individual will always regain control of the principal originally deposited. At the same time, the asset appreciation in excess of the annuity payments is removed from the grantor’s estate and is not subject to estate tax. If you’re interested in a GRAT or would like to discuss other estate planning options, please contact your RegentAtlantic Wealth Advisor.

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.

This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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