The grantor retained annuity trust (GRAT) is one of the most powerful tools used to transfer wealth across generations, while bypassing estate and gift taxes. Assets that are expected to appreciate are transferred to the trust for a retained annuity plus interest to the grantor over the term of arrangement. As explained in Bloomberg BNA's article, "Future of Popular Estate-Planning Tool May Hinge on Election," when the trust expires, any remaining assets left after the annuity is paid are given to beneficiaries tax-free. This is a simplified and very brief version, but Facebook CEO Mark Zuckerberg and Lloyd Blankfien, CEO of Goldman Sachs, are just two of the many boldface names using this method to protect their billions.
President Obama has been pushing to modify the transfer tax rules for GRATs in his annual budget proposals since 2010. Earlier proposals called for requiring a minimum term for GRATs, but the most recent proposals have included additional changes.
If Democratic front-runner Hillary Clinton wins, experts think many of her policies will be in line with the Obama administration, like the estate tax. Clinton says she wants to restore the parameters that were in place in 2009, which would reduce the tax exemption threshold for estates to $3.5 million and $7 million for a married couple. There would be no adjustment for future inflation, and the top tax rate would be increased from 40% today to 45%. A Clinton administration may advocate for limiting GRATs. But unless there's a Democratic-controlled Congress, those changes won't occur.
If presumptive Republican presidential nominee Donald Trump wins the election, the proposals on GRATs would go away because Trump's tax plan would repeal the estate tax and remove restrictions on GRATs.
In addition to the recent budget proposals, rising interest rates could also affect the viability of GRATs in the long term. With lower interest rates, the property transferred to the GRAT doesn't have to appreciate as much as it would with higher interest rates for the GRAT to be a successful method of transferring wealth to remainder beneficiaries.
In a grantor retained annuity trust, if the assets produce a return in excess of the tax code Section 7520 rate, the increase in value above the rate is the responsibility of the beneficiaries. The IRS defines the Section 7520 interest rate as 120% of the applicable federal midterm rate, compounded annually. Typically, as interest rates increase, the ability to effectively execute a successful GRAT decreases. That's because the Section 7520 rate that the investments need to exceed is greater. Over time, when interest rates go up to 2 to 4%, it'll eventually diminish the effectiveness of the GRAT.
If you are interested in learning more about the use of GRATs and other wealth transfer methods, speak with an estate planning attorney who understands these complex instruments.
Reference: Bloomberg BNA (May 31, 2016) "Future of Popular Estate-Planning Tool May Hinge on Election"