Will a GRAT Help Fund Your Retirement?

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Walter had accumulated a modest fortune during his years as a successful businessman. As he looked ahead toward retirement, his estate planning attorney suggested some options that might provide him with an income. They considered several strategies, including buy-sell agreements and trusts. Walter was most interested in a GRAT.

What is a GRAT?

GRAT is an acronym meaning Grantor Retained Annuity Trust. The grantor – the person who created the GRAT – typically funds the trust with assets that are likely to appreciate. The grantor then receives annual annuity payments for the life of the trust. When the trust terminates, any assets remaining in the trust transfer to the heirs with little or no tax consequences.

A GRAT may be used to transfer wealth to family members while avoiding gift taxes.

GRATs also may provide the grantor with the money to retire gracefully.

Based on the rate contained in IRS Section 7520, annuity payments are calculated using either:

  • The interest earned from trust assets; or
  • A percentage of the total value of the trust assets.

GRATS may sound great, but they are not perfect.

A Few Drawbacks

Grantors or trustees may violate IRS Section 2702 if:

  • The trustee fails to pay the annuity to the grantor within the grace period, which is 105 days.
  • Any additional contributions are made after the GRAT is established.
  • The annuity payment increases by more than 120 percent over the last year’s annuity.
  • The GRAT issues a promissory note to the grantor instead of the annual annuity payment.

Violations could result in substantial penalties.

Sometimes the GRAT grantor passes away before trust termination. In that case, the trust assets become part of the grantor’s taxable estate. The beneficiaries receive nothing directly from the trust.

Can a GRAT Help Fund Retirement?

For some people, the answer is “Yes.” However, a GRAT should not be entered into lightly. It’s best to discuss all options with your estate planning attorney and financial advisors.