So you're not familiar with Grantor Retirement Trusts, better known as GRATs? This may not be a bad thing, considering that this speculative estate planning tool has a questionable future – at least as it currently exists. In any case, financial advisors who guide their clients to GRATs should do so carefully and only with clients who have the appropriate assets.
How they work
In short, GRATs are irrevocable trusts that wealthy individuals (donors) shift substantial sums of money to family members while avoiding traditional estate and gift tax liabilities, both of which are currently at 40%. And as the name suggests, the concessionaire, usually a family man, retains the right to collect annual annuity payments for a certain number of years, then any remaining assets in the GRAT are distributed to beneficiaries of the lender's choice. (For more information, see: Estate Planning Tips for Financial Advisors .)
For GRATs to be successful, the underlying investments must exceed a hurdle rate known as the "7520 interest rate." is known – a figure declared at the time of the start of the fund. The 7520 rate is charged monthly by the Internal Revenue Service and is linked to the auction of Treasury bills worth 3 to 9 years. In November 2015 the rate was 2% at 7520 for example. So if a Patriarch has a portfolio of high yield bonds with an interest rate of 7%, the difference between their ultimate return and the value of 7520 would be 5% – a net gain that tax-free family members will pocket for the next generation. And with today's value of 7520 at historic lows, GRATs have been an attractive transfer vehicle lately. But that could change if the 7520 rate rises when it hit an all-time high of nearly 12% in 1989. That's why financial advisors are encouraging wealthy clients to lock in GRATs sooner rather than later, before the pendulum swings the other way. ..
But aside from 7520, any stock or fund investment can obviously fall below that 2% threshold and leave the next generation with nothing. That's why wealthy individuals often diversify their positions across multiple GRATs to ensure that reliable winners aren't dragged down by more speculative investments. (See more at: Tips for handling client inheritance .)
Calculation of the annuity
It is preferable to express the amount of the annuity, which can be paid monthly, quarterly or semi-annually. a fixed percentage of the property in the trust. The rules require that the amount of the annuity payment be increased over the life of the GRAT, but not more than 120% of the amount paid in the prior year. Annuity payments are based on either the GRAT's tax year or the anniversary date of the GRAT.If it is the latter, the payment must be made within 105 days of the trust start date.
Going the Distance
GRATs require an important consideration. Only healthy would-be donors should take the plunge, because donors must meet the terms of the GRAT for the vehicle to work. If the grantor dies before the GRAT matures, the asset transfer initiative goes up in smoke. (For more information, see: Top tips for helping clients issue an inheritance .)
Currently, government regulations provide for a GRAT period of two years. As a result, grantors have often implemented a series of two-year GRATs to circumvent this law. But a change may be in the works. Due to the Obama administration's efforts to raise tax revenues for the country, several budget proposals aim to minimize the effectiveness of GRATs as estate reduction tools by increasing their current two-year minimum to 10 years. This would increase the likelihood that lenders would die during the life of the trusts and consequently withdraw assets into their taxable estates. In addition, the Obama administration is proposing "zero-out" Abolish GRATs. This refers to GRATs where the grantor's retained interest is valued identically to the fair market value of the assets transferred to the trust. And their projected growth is dictated by 7520, reducing the taxable gift to almost zero. (For more, see: What advisors can learn from ultra-wealthy clients .)