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Grantor Retained Annuity Trust

Now could be a great time to use tax-free GRATs to shift stock to children.

MARKET CONDITIONS
A lot of stocks are off considerably from the highs of recent times. If one thinks his stock portfolio is due for a rise, then a GRAT may be an advantageous estate planning tool.

WHAT IS A GRAT?
A GRAT is an estate planning bet that the contributed stock will outperform the IRS interest rate. (4.6% for September 2002, the lowest rate on record). The goal is to transfer, gift and estate tax free, marketable stock to the trustmaker's children. The $10,000 (currently $11,000) per person annual gift tax exclusion is not used here, so that gifting can continue as well.

HERE'S HOW IT WORKS
The trustmaker transfers say $1 million of marketable securities to a two year GRAT paying an annuity of about $535,000 per year for the two years. If the stocks don't appreciate, or even decline, the GRAT can't make the full payments; the children get nothing ( the trustmaker gets it all back). That's a tie, because if the trustmaker had done nothing at all, the stocks would have gone down, and the children would have received nothing anyway.

However, if the stock appreciates (including the dividends paid), there may be stock value remaining in the trust after the trustmaker receives back his annuity payments. That remaining stock passes to the children free of gift tax. This is the "win", or probably more appropriately, the rare "free lunch" in tax planning. If the stock paid a dividend of 1.5% and grew 4.5% per year, approximately $22,000 would pass to the children free of any gift tax etc.

HEADS I WIN TAILS I TIE
Because GRATs are "heads I win, tails I tie", volatility of the markets can result in a significant advantage. Obviously, tax planning should NEVER dictate an investment strategy. But, if the trustmaker's strategy as to certain stocks is a "buy and hold" strategy, the use of a GRAT may be appropriate. The trustmaker should discuss any GRAT strategy with his investment advisor.

The other "tie" (in a tax sense) is that if the trustmaker dies before the end of the two-year GRAT period, the stock passes tax-free.

The up front gift of a GRAT transaction is equal to the value of the stocks initially contributed minus the value of the annuity (here, for two-years) you receive back. If the annuity value is exactly equal (under IRS tables) to the amount contributed, the amount of the taxable gift is $0.

ACT ON THE OPPORTUNITY?
In a sense, the use of a GRAT is a "use it or lose it" opportunity, much like the annual gift exclusion. Think about the fact that any time there are significant market gains and a GRAT is not in place, an opportunity to make tax-free gifts has passed away. Many people choose to stay "fully-invested" in GRATs (by directing the annuity payments from one GRAT to a new GRAT) on the belief that in the long run equity investments will outpace the IRS interest rates.

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