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Grantor Retained Annuity Trusts

A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust to which a donor transfers assets and retains the right to receive a fixed dollar amount (the annuity) from the trust for a specified period. At the end of the period, the property remaining in the trust passes to the designated beneficiary of the donor’s choice. The benefit of a GRAT is that any income and appreciation generated by the assets in the trust which are in excess of the annuity amount pass to designated beneficiaries free of income and gift taxes. The grantor’s interest in the assets is “frozen” at the annuity payments.

Tax and Other Benefits of a GRAT

Gift Tax Benefits

The transfer to a GRAT is a completed gift for gift tax purposes. However, the value of the gift of the remainder interest can be structured to be nearly zero. This is accomplished by adjusting the annuity rate and the term of the trust so that the present value of the retained annuity interest is equal to the property transferred to the trust.

Income Tax Ramifications

The GRAT is treated as a “grantor trust,” which means that the donor is taxed on income and realized gains on trust assets even if these amounts are greater than the trust’s annuity payments. This can have additional benefit as a wealth-shifting and estate-tax-savings device. The transferor is effectively allowed to make tax-free gifts of the income taxes that are really attributable to assets which will pass to the remainder beneficiaries of the trust.

Annuity Payment

The annuity amount must be paid to the donor on an annual basis. If the income earned on the trust assets is not sufficient to pay the annuity, principal must be used. There should be no income tax consequences from distributing principal.

Trust Termination

At the end of the trust term and the payment of the annuity amount to the grantor, any remaining trust property will be paid to the grantor’s children or to trusts for their benefit. If the cumulative return generated by the trust assets (principal growth plus income) has exceeded the annuity payments, there should be assets to distribute. For a short-term GRAT, there should be an expectancy of larger returns to warrant having the GRAT. Because the transfer to the trust is a completed gift for gift tax purposes when created and since the grantor will have paid tax on all trust income earned before termination, the distribution to the children at the termination of the trust should be free of any gift or income tax.

If the grantor dies before the end of the trust term, a portion or all of the trust will be included in the grantor’s estate for estate tax purposes, in which case no estate tax benefit will have been achieved for that includable portion.

B|O|S maintains an estate planning glossary that further defines many of the terms used in this memo. If you wish to receive a copy of the glossary, please contact a member of your dedicated service team.

Updated January 2018

Disclosure:

This white paper is for informational purposes only and is not intended to be used as a general guide to investing or financial planning, or as a source of any specific recommendations, and makes no implied or express recommendations concerning the manner in which any individual’s account should or would be handled, as appropriate investment strategies depend upon the individual’s specific objectives. It is the responsibility of any person or persons in possession of this material to inform himself or herself of and to seek appropriate advice regarding any investment or financial planning decisions, legal requirements, and taxation regulations which might be relevant to the topic of this white paper or the subscription, purchase, holding, exchange, redemption or disposal of any investments.

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Opinions expressed are current opinions as of the date appearing in this material only and are subject to change. No part of this material may, without the prior written consent of Bingham, Osborn & Scarborough, LLC, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.

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