In our last blog on “Planning With GRATs”, we discussed how a Grantor Retained Annuity Trust (GRAT) can be an effective wealth transfer technique without incurring a gift tax or utilizing one’s lifetime gift tax exemption. A risk, however, with a long-term GRAT is if the Grantor dies prior to the expiration of its term. Death of the Grantor would subject the trust assets, including any income and appreciation, to estate tax. To reduce the mortality risk (especially for elderly clients or for those with health concerns), there is an estate planning technique that utilizes shorter-term GRATs.
The “Rolling GRAT” technique involves creating a series of consecutive short-term GRATs (typically 2 to 3 years) with each successive GRAT funded by the previous trust’s annuity payments. Rolling GRATs minimize the risk of mortality during the term and thereby increases the success of transferring wealth. Short-term GRATs can take advantage of asset volatility. In fact, research on GRATs funded with publicly traded stock showed that a series of rolling GRATs outperformed an identical long-term GRAT, regardless of the 7520 rate at time of creation. The study showed that the short-term GRAT strategy minimized the risk that good investment performance in one year would be offset by poor performance in another year. Rolling GRATs also keep more funds committed to the estate planning strategy.
If the short-term GRAT strategy is effective (assets appreciate faster than the IRS Section 7520 rate within the trust term), wealth is removed from the taxable estate and transferred to beneficiaries at little cost. If the strategy is not effective (assets did not outperform the IRS Section 7520 rate), all of the assets would go back to the Grantor in form of the annuity payments and none of the lifetime gift tax exemption would be wasted. Win Win!
Rolling GRATs also offer the advantage of plan and strategy flexibility. The Grantor can stop the rolling process at any time and for any reason. For example, the Grantor may wish to stop if he or she needs the income from the trust assets, no longer has an estate tax concern, wants to transfer wealth to the beneficiaries sooner, the assets’ growth rate drops too low, or his or her health has deteriorated and is not expected to live for another 2 or 3 years. The disadvantage of a short-term GRAT is that a particularly low Section 7520 rate will not be locked in long-term.
While Rolling GRATs offer advantages for liquid assets, such as publicly traded stock, illiquid or hard-to-value assets are better suited for long-term GRATs. In particular, illiquid assets would require frequent valuations that may be subjective, cumbersome and costly.
It is important to note that a provision in the President Obama’s 2014 Budget seeks to eliminate the use of short-term GRATs. The proposal would require that any new GRAT have a minimum term of 10 years and would require that the remainder interest have a value greater than zero at the time the interest is created. This minimum 10 year term would not eliminate the use of GRATs, but it would increase the risk that the grantor would fail to outlive the GRAT term and lose the anticipated transfer tax benefit.
Whether the proposed measures will be enacted or even considered by Congress remains to be seen. However, taxpayers planning for the future may wish to take advantage of GRATs now, before any new restrictions are implemented. Contact the Pierro Law Group to find out how you or your clients can utilize Rolling GRATs or other estate planning techniques.