At its core, a Grantor Retained Annuity Trust (GRAT) is a tool used to make a tax-free gift. And it may be just the right time to consider setting one up for yourself.
Here's how it works: the donor creates a trust which calls for certain payments to be made to themselves over a period of time, and then whatever is left in the trust passes to the beneficiaries named by the donor.
Specifically, the tax-free part is accomplished by a complex calculation that "zeros out" the GRAT. Zeroing out simply means that the anticipated value of the remaining assets in the trust (the part that is paid to the beneficiaries) is expected to be zero.
At this point you're probably asking yourself, "if the remainder is expected to be zero, what's the benefit?" Well, the benefit occurs if the assets in the trust outperform the calculation. And the calculation follows a rate of return published by the IRS which is updated monthly. This calculation is based on the rate in effect at the time the trust is created and funded. Therefore, the rate published by the IRS has a major impact on the effectiveness of this tool.
For instance, if the published rate is 2%, but your assets see a return of 8%, you have been able to make a tax-free gift of the 6% differential. This is why timing is everything. If you time things properly, you can make a substantial tax-free gift. If you time things poorly, the effort can fail. (failure just means that you didn't get to make a gift) There is no penalty, but you are out the time and cost of setting up the trust in the first place.
So, the big question is: is now a good time to set up a GRAT?
I don't have a crystal ball, but it certainly appears to be a great time. The rate published by the IRS for May of 2020 has dropped to .8%. Yes, 8/10 of a percent. No, not 8%, eight-tenths of a percent, which is a historic low.
The stock market is still down from where it was earlier this year, so if you think your investments will return more than eight-tenths of a percent over the coming years, it seems like a great time for a GRAT.
If this is of interest, or if you have other planning questions, please feel free to reach out. I can be contacted via email at firstname.lastname@example.org or by phone at 765.423.7900.