How to Transfer Wealth without Triggering the Gift Tax

Use the Grantor Retained Annuity Tax (GRAT) as Part of Your Wealth Transfer Strategy

What to Look For

Many high-net-worth individuals would like to shift their wealth to the next generation without incurring stiff tax penalties. The Grantor Retained Annuity Trust (GRAT) may be just the vehicle for accomplishing the transfer.

Individuals seeking ways to make an irrevocable gift to a trust for the benefit of family members, while still maintaining an income stream, may use a GRAT as part of their wealth transfer strategy.

A GRAT is a useful strategy to shift wealth from one generation to the next with little or no gift tax. A GRAT allows the grantor to retain some interest income for a period of time, and then ultimately transfer assets to children with the potential for no gift tax.

The Opportunity

An individual can set up an irrevocable trust for the benefit of family members and transfer assets to the trust. As a condition of the transfer, the donor receives annual annuity payments for a period of years. The theory behind the GRAT is that the structured payment stream is equal to the value of the transferred property, plus an appropriate rate of interest for the specified term, so that the present value of the gift is zero at the date of the gift. Because the present value of the gift is zero, there is no gift tax on the transfer.

It’s worth noting that not all of an individual’s assets are appropriate for GRAT treatment. A portion of the assets (i.e., the annuity payment) must be distributed to the grantor on each anniversary of the GRAT, so the assets should produce enough cash flow in the GRAT to fund the payment stream. Donors should look to use a mix of income-producing assets, coupled with assets that will appreciate in value beyond the rate of return built into the annuity payment, leaving assets in the trust at the end of the annuity term.

The Benefit

The amount of the gift value is minimized because of the annuity payment (i.e., retained interest). If this is structured properly, it will not result in a current gift. Additionally, the income of the GRAT is taxed to the donor, so there are additional estate savings because the trust assets aren’t depleted for taxes. Note that the trust assets can remain in the trust beyond the annuity term. Should the donor die before the end of the trust term, however, the assets would be included in the donor’s estate.

If you have questions about this or want more information, contact your ALL tax advisor or call us at 617-738-5200.