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Market Analysis

A grantor retained annuity trust (GRAT) is a highly effective estate planning tool to be used with assets likely to appreciate in value.  A GRAT is an irrevocable trust from which the grantor retains the right to receive annuity payments for a specified term of years.  At the end of this retained term, assets contained in the trust pass to other remainder beneficiaries.  The annuity payments made to the grantor during the term dramatically reduce the value of the gift of the remainder interest when the GRAT is established, so that only the net present value of the remainder interest is subject to gift tax.  A GRAT produces estate and gift tax savings if the assets placed in the GRAT produce a total net return (net income and appreciation) in excess of the assumed discount rate under the Internal Revenue Code.

The annuity payments may be set sufficiently high so as to create a "zeroed-out" GRAT.  With a zeroed-out GRAT, the net present value of the retained annuity payment stream equals 100% of the value of the assets placed in the trust.  If the assets in the GRAT appreciate in value beyond the amount necessary to produce the retained annuity payments, then the value of the trust remaining at the end of the term of the trust will pass to the designated beneficiaries free of gift and estate taxes.

There is virtually no downside to creating a GRAT.  If the grantor dies before the expiration of the term of the GRAT, the assets remaining in the trust will be included in the grantor's taxable estate, with an appropriate credit being given for any gift tax paid when the trust was created.  Similarly, if the trust assets decrease in value, so that there is nothing remaining in the trust at the expiration of the term, the grantor is returned to the same position as he or she was in prior to creation of the GRAT, with no tax costs having been incurred.  In both instances, the grantor's loss is limited solely to the costs associated with establishing the GRAT.

A zeroed-out GRAT is an excellent estate planning tool for an individual who has exhausted his or her applicable exclusion amount under the federal estate and gift tax laws and who is already maximizing annual exclusion gifts.  The GRAT presents a way to pass excess growth and appreciation in assets to children without incurring gift or estate tax.  While such a technique works only if the assets placed in trust appreciate beyond the applicable federal discount rate, the grantor is generally able to identify which assets are likely to do so.  A GRAT generates the greatest transfer tax benefit in a low interest rate climate because it is more likely that the return on assets held by the GRAT will exceed the low interest rate.

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