Grantor Retained Annuity Trust (GRAT)

A grantor retained annuity trust (GRAT) is an estate-planning tool that lets a grantor transfer assets into an irrevocable trust, retain the right to receive annuity payments for a fixed term, and pass any remaining appreciation to designated beneficiaries with little or no gift tax cost.

How a GRAT works

• The grantor funds an irrevocable trust with assets (cash, securities, business interests).
• The trust pays the grantor an annuity—either a fixed dollar amount or a percentage of trust value—each year for a set term.
• When the term ends, any remaining assets (the “remainder interest”) pass to the beneficiaries.
• The IRS treats the transfer to the trust as a gift equal to the present value of the remainder. The annuity stream reduces that present value for gift-tax purposes; in a “zeroed-out” GRAT the calculated remainder is effectively zero, minimizing reported gift value.

Tax mechanics

• Estate vs. gift taxes: Lifetime taxable gifts and an estate’s value are combined for federal gift and estate tax purposes subject to the lifetime exclusion. Annual per-recipient exclusions also reduce taxable gifts.
• 7520 rate: The IRS publishes a Section 7520 rate used to compute the present value of the annuity and remainder. If trust assets appreciate at a rate higher than the 7520 rate, the excess appreciation passes to beneficiaries free of additional gift tax.
• Death during the GRAT term: If the grantor dies before the GRAT term ends, the remaining trust assets are generally included in the grantor’s taxable estate, eliminating the intended transfer-tax benefit.

Uses and benefits

• Freeze estate value: GRATs are used to shift future appreciation (not current value) of assets to heirs while minimizing use of lifetime exclusion.
• Best for high-growth assets: Especially effective when funding with assets expected to outperform the IRS-assumed 7520 rate (for example, pre-IPO shares or concentrated holdings with high appreciation potential).
• “Zeroed-out” strategy: Structuring annuity payments so the calculated remainder value is near zero can eliminate reported gift value while still allowing future appreciation to pass to beneficiaries.

Risks and limitations

• Mortality risk: If the grantor dies during the GRAT term, the strategy fails to remove the assets from the taxable estate.
• Market risk: If assets depreciate or fail to exceed the 7520 rate, there will be little or no remaining value for beneficiaries.
• Complexity and costs: GRATs require careful drafting, valuation, trustee administration, and tax reporting; legal and trustee fees can reduce net benefits.
• State taxes: Some states or localities impose inheritance or estate taxes that can affect outcomes; rules vary by jurisdiction.
• Compliance scrutiny: Aggressive or repetitive zeroed-out GRAT structures may attract IRS attention and should be implemented with professional advice.

History and notable examples

GRATs became widely known after favorable tax-court rulings in the early 2000s demonstrating the effectiveness of zeroed-out designs. Prominent estate-planning uses include founders transferring pre-IPO stock into GRATs to shift appreciation to heirs.

Practical considerations

• Term length: Shorter-term GRATs (two to five years) are commonly used but increase mortality risk; longer terms reduce that risk but delay transfer of remainder.
• Choice of asset: Use assets with high expected appreciation relative to the 7520 rate and acceptable liquidity for annuity distributions.
• Trustee selection: Choose a trustee capable of managing the assets, making annuity payments, and handling valuations and tax reporting.
• Professional advice: Work with an experienced estate-planning attorney and tax advisor to design and document the GRAT, calculate annuity amounts, and evaluate gift/estate-tax consequences.

Bottom line

A GRAT can be an effective way to transfer future appreciation to heirs with minimal gift-tax consequences when structured correctly and funded with assets likely to outperform the IRS-assumed rate. Because of irrevocability, valuation, and mortality risks—as well as complex tax rules—professional legal and tax guidance is essential before establishing a GRAT.