The Grantor Retained Annuity Trust (“GRAT”) is an advanced estate planning tool that benefits people with a high net worth who want to reduce their estate tax and gift tax burden while making a large transfer of appreciating assets to their children, grandchildren, or other beneficiaries. Here’s how it works:

You, as the grantor, set up an irrevocable trust and fund it with a single transfer of assets. The assets have to be income-producing, and they should be expected to appreciate at a rate higher than the IRS assumed rate of return. When you establish the trust, you also set a termination date for the trust. While the trust is in existence, the trustee pays you an annuity from the trust. Your annuity is either a fixed dollar amount or a percentage of the trust income. At the termination date of the trust, the trustee distributes the trust assets to the beneficiaries you named when you established the trust.

Here’s why there’s a tax savings:

You save on estate tax because, by making the transfer of assets, you’ve reduced the overall size of your estate, and therefore the amount of your estate tax. The estate tax on the trust assets is calculated as of the date the assets are transferred to your beneficiaries, so the strategy only works if you’re alive when the transfer happens. If you die before the trust terminates, then the strategy fails and your estate is taxed on the value of the assets.

You save on gift tax because, although you do pay gift tax on the transfer, you only pay it once, and it’s when the assets are funded into the trust. So, assuming the assets appreciate at a higher rate of return than that predicted by the IRS, your beneficiaries may receive a great deal of money tax-free.

GRATs are not for everyone, and there is a certain amount of gambling involved in establishing one. A qualified estate planning attorney can help you determine whether a GRAT is right for you.

The Law Offices of James A. Miller is a member of the American Academy of Estate Planning Attorneys.

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