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Is a grantor retained annuity trust right for you?

Many financial and legal practitioners have been advocating the usage of grantor retained annuity trusts (GRATs) for the past several years. This widely used estate-planning strategy has gained in popularity as the U.S. economy has embarked on a repressed interest-rate environment which has helped provide a boost to household net worth.

The general overview of a GRAT can be explained as follows: An individual, referred to as the “grantor,” creates an irrevocable trust, transfers assets to it and retains an annuity from the trust for a specified term. GRATs have a minimum term of two years but can be longer in duration. To avoid a gift tax, the retained annuity is designed to equal the value of the assets transferred, based upon the term of the trust and an assumed growth rate established by the Treasury department. The rate set forth by the Treasury is known as the “7520” rate. Should the total return on the assets placed into the trust outperform the 7520 rate, the excess value passes to the next generation free of gift and estate taxes. Many tax professionals will refer to this as a successful GRAT or a GRAT that’s “in the money.”

An individual may gift a substantial amount of wealth utilizing a GRAT, while retaining an income interest for a specified period of time. Given the retained interest, there’s a significant reduction and, in some cases, elimination of any taxable gift.

One can choose to also place assets such as marketable securities, private stock or a portion of the family’s business into a GRAT. Once this gift has been made, it’s irrevocable, meaning these assets are there for good or until the GRAT terminates and the assets pass to the designated beneficiaries.

Generally speaking, assets that have the potential for greatest gain should be considered. Upon gifting such an asset, the post-appreciation will be excluded from one’s estate and passed on to the next generation without incurring estate taxes. Investors should also consider placing non-marketable assets, such as a family business or private stock, which can result in a valuation discount due to lack of marketability.

The GRAT technique does carry some risk. Should the grantor die prior to the expiration of the term, the GRAT is deemed to be unsuccessful. If this situation were to occur, the entire value of the trust would be included in the taxable estate. To reduce this mortality risk, many advisors recommend shorter-term GRATs for elderly individuals or those families who have health concerns. Jay Rivlin of McDermott Will & Emery LLP says: “Clients who have systematically utilized GRATs have transferred significant wealth over the years. It usually only takes one ‘winner’ to make a GRAT program very worthwhile.”

GRATs remain a viable and effective tool for wealth-transfer planning. To effectively examine whether a GRAT is right for your family, you should consider a sum of all the financial parts and consult a qualified advisor or tax professional for the implementation of such a plan.

Stephen A. Schwartz offers advisory services as a representative of Northwestern Mutual Wealth Management Company (WMC), a limited purpose federal savings bank, and a subsidiary of The Northwestern Mutual Life Insurance Company, Milwaukee, Wis., (NM). Northwestern Mutual is the marketing name for NM and its subsidiaries. Stephen A. Schwartz is an insurance agent of NM (life and disability insurance, annuities and life insurance with long-term care benefits) and a registered representative of Northwestern Mutual Investment Services, LLC (NMIS) (securities), an NM subsidiary, broker-dealer, investment advisor, member FINRA, SIPC. Pioneer Financial is a marketing name used by a group of Northwestern Mutual representatives (not all of whom are affiliated with WMC) including Stephen A. Schwartz (referred to as the “firm”), and is not a legal entity, partnership, investment advisor, broker-dealer or affiliate of NM. The views expressed herein are those of the author and may not necessarily reflect the views of Northwestern Mutual.

This article was originally published in the February/March 2015 issue of Worth.


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