For Estate Planning, a GRAT Can Be Where It's At

A look at a trust that works well for income-producing real estate and appreciating stock portfolios.
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A GRAT sounds like something you should park behind your garage. But it's actually a beautiful estate-planning tool for the right situation. A GRAT, or grantor retained annuity trust, is an ideal tool to use to minimize estate taxes on income-producing assets or an appreciating stock portfolio.

As part of my continuing series on estate planning, I've been looking at various tools and trusts. Previously, I have examined

irrevocable life insurance trusts,

credit shelter trusts and

simple wills.

A GRAT enables you to transfer assets out of your estate and have them valued at a fraction of their current value for estate-tax purposes. Such a transfer allows you to retain a stream of income from the assets for a fixed number of years. Before getting more specific, let me suggest who may benefit the most from using a GRAT. Generally, it would be someone who:

  • Owns an asset that is going up in value and providing income. The best examples would be an income-producing piece of real estate or a stock portfolio.
  • Won't need the income from the asset beyond the term selected for the trust, e.g., 10 years.
  • Has a reasonable chance of living for the entire term of the trust. If the person dies before the end of the term, the asset goes back into the estate.
  • Has an asset valued at more than the lifetime estate-tax exemption, currently $650,000. Since you won't pay estate taxes on the first $650,000 of assets (the exemption rises to $675,000 in 2000), you don't need to shelter anything worth less than that.
  • Does not have a problem relinquishing ownership and control of the asset after the termination of the trust. At that point, the asset will go to the beneficiaries. In most cases, that will be the kids, but it could be anybody.

To see how this works, let's look at a couple of examples.

Sarit is a 65-year-old widow who will live at least 10 more years (this could also apply to a married couple). In addition to a $650,000 taxable estate, she owns an apartment complex worth $500,000 that is producing $40,000 in income per year.

Assume she only needs to receive that income for another 10 years and that she wants the property to go to her kids after that. She decides to transfer the apartment complex to a GRAT and makes the kids her beneficiaries. When the transfer is made, the apartment complex is discounted to $250,000 using a formula that reduces the present value of the property to account for various expenses and the value of the income that will be taken out over the years.

If Sarit does not transfer the property to the GRAT, its value could easily rise to $750,000 in 10 years. That extra $500,000 of value (over the $250,000 discounted value in a GRAT) would cost the estate approximately $250,000 in additional estate taxes.

Now, let's look at the case of Jack, age 65, who has a $1 million stock portfolio. Jack decides to create a GRAT for his two adult children. He transfers the stock portfolio to the GRAT and decides to take an 8% per year annuity for 10 years. That will give him $80,000 a year in income. The income comes from dividends and appreciation of the stock. If the stock doesn't appreciate enough, the money is paid out of principle after some stock is sold.

After checking with the applicable

Internal Revenue Service

tables, it turns out that the value of the stock portfolio for estate-tax purposes is reduced to $500,000 for the 10-year term of the trust and will be frozen at that level. That saves estate taxes on the other $500,000 as well as any further appreciation over the 10 years. The portfolio could easily grow by more than the 8% being distributed each year. That additional growth will pass to the kids free of estate taxes. After 10 years, the trust terminates and the trust property passes to the kids.

One of the important concepts to keep in mind is that the higher the payment from the GRAT, the lower the present value is. For instance, if Jack had taken a 10% annuity each year for 10 years, the remaining interest would be approximately $300,000 instead of $500,000. A similar result could be achieved by extending the term of the trust to 15 or 20 years. The problem with extending the term is that you must live to the end of the trust's term or it will be put back into your estate.

I realize most of these estate-planning concepts apply to people over age 50 or 60, so those of you that are younger may not worry so much about these kinds of problems. However, if your parents are in this category, you could encourage them to do something about it.

As we head into the next millennium, we will be experiencing a transition into a new era. May it bring peace, health and prosperity to all of you.

Vern Hayden is a certified financial planner in Westport, Conn. He is a financial consultant and advisory associate of Financial Network Investment Corp. He also is an owner of Hayden Financial Group. His column is not a recommendation to buy or sell stocks or to solicit transactions or clients. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. While he cannot provide investment advice or recommendations, Hayden welcomes your feedback at