It is likely that you’re going to have multiple objectives when you’re putting together a comprehensive estate planning strategy, and achieving them can seem like a daunting task. The good news in this regard is that there are a number of estate planning vehicles that enable you to reach multiple objectives through the execution of a single document. Those who would like to reduce the taxable value of their estates, receive a steady stream of income, and quite possibly provide a tax-free gift to an heir may do well to consider the creation of a grantor retained annuity trust or GRAT.
The key to the successful execution of the strategy is to fund the GRAT with assets that you would expect to appreciate considerably over the length of the trust term. When you are creating a grantor retained annuity trust, you set the term and you name a beneficiary who will receive any remainder that might exist after the conclusion of this term. At this point the funds are no longer part of your estate for estate tax purposes.
However, the IRS will determine the taxable value of the gift into the trust using 120% of the federal midterm rate that was in place during the month that the trust was created. This strategy involves “zeroing out” the GRAT, so you take annuity payments over the course of the term of the trust that are equal to the total taxable amount of the initial contribution. In so doing you are personally retaining all the interest in the trust so there is no gift tax due.
The grantor retained annuity trust becomes successful when the assets that have been placed into the trust outperform the IRS estimate of the interest that the initial contribution would typically earn over the course of the term. If such a remainder does exist after all the annuity payments have been made and the trust term expires, it passes to your beneficiary and no further taxes are levied.