How Does a Grantor Retained Annuity Trust Work?

With a grantor retained annuity trust (GRAT), a grantor can transfer assets at a greatly discounted value for gift tax purposes, thereby removing them from his or her estate, while continuing to enjoy income from the assets for life or for a specified term.  This tool works especially well for taxpayers with large estates, who can comfortably give up income-producing assets.  Structured correctly, a GRAT can allow the grantor to transfer assets worth millions of dollars with little or no gift tax incurred. 

Here is how a GRAT works:

1. The grantor creates the trust—an irrevocable trust funded with income-producing assets such as investment real estate, S corporation stock, etc.;
2. The grantor names a beneficiary (usually his or her children) and a trustee (usually someone other than the grantor);
3. The grantor receives a fixed amount at least annually for life or for a specified term;
4. Upon the grantor’s death or at the end of the specified term, the trust terminates and distributes the remainder interest to the beneficiary.

The taxable value of the gift equals the value of the property transferred to the trust minus the value of the grantor’s retained interest as long as it is a qualified retained interest.  The grantor must abide by certain rules and avoid numerous pitfalls to make sure his or her retained interest qualifies.

GRATs are complex estate planning tools requiring the guidance of a qualified estate planning attorney who can design the trust based on the client’s unique needs.