Looking to reduce estate tax liability? Some of the most valuable strategies for achieving this involve “squeezing” and “freezing” assets — in other words, discounting assets in various ways and locking in lower asset values.

One way to freeze assets, maintain some control over them and enjoy an income stream is to set up a grantor retained annuity trust (GRAT). Grantor Retained Annuity Trusts are wealth transfer tools that allow a family to transfer wealth without worrying about taxes and other risks.

How does it work?

A GRAT is structured to pay you a fixed annuity for a specific term. During the term, you control the assets and enjoy an income stream in the form of the annuity payments. After the term’s end, the assets remaining in the GRAT are transferred to the beneficiaries.

Rules

For a GRAT to be an effective wealth transfer technique, the GRAT assets must grow at a greater rate than what the IRS requires you to pay yourself back in interest on the principal, known as the § 7520 rate (3.4% for GRAT’s created in July, 2018). Otherwise you’ll essentially just be transferring the GRAT assets back to yourself through the annuity payments.

Gift tax cost of funding?

With proper planning, the gift tax cost of funding a GRAT can be minimal. The value of your initial transfer to the GRAT for gift tax purposes is equal to the actuarial value of the beneficiaries’ future interest in the trust. By adjusting the length of the trust term and the size of the annuity payments, you can significantly reduce the value — possibly even to zero (these GRATs are referred to as “Zeroed-Out GRATs).

But there is a risk, especially when a GRAT has a longer term: If you don’t survive the trust term, the GRAT assets will be pulled back into your taxable estate.

There are other ways to “squeeze and freeze” assets – learn more about them in our blog “Tax Cuts and Jobs Act Estate Planning Strategies” As always, our Private Client Tax Services Team can help you navigate the rules.

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