Many high-net-worth individuals in Texas have discovered that although low interest rates are wonderful for borrowers – particularly young couples getting into houses – they are truly challenging for investors. When one adds the complexity of state and federal estate tax laws and the contingent nature of our political system, investors really face challenges in passing along assets to children and grandchildren in as efficient a manner as possible.
One tool that might be right in the sweet spot for many Texans is the creation of a grantor retained annuity trust (a “GRAT”). Properly crafted, the GRAT can be a relatively simple way to transfer property to your children at virtually no gift tax cost.
Typically, the grantor contributes assets to a trust that requires the payment of an annual annuity payment for a fixed number of years (the “annuity period”). Most often, the annuity amount is a stated percentage of the initial fair market value of the trust – either a fixed percentage or a stated percentage that can increase as much as 20 percent per year over the annuity period.
During the annuity period, the interest must be paid. If insufficient income is available, the payment must come from principal. At the end of the annuity period, any property remaining in the trust passes to the ultimate beneficiaries of the trust – usually children or grandchildren. A variant is to delay the transfer of assets to children and grandchildren by naming your spouse as an intermediate beneficiary.
While the original transfer of property to a GRAT constitutes a gift for gift tax purposes, the value of the gift is only the value of the trust assets on the date of the transfer, reduced by the present value of the annuity you have retained. The calculation of the present value of your retained annuity is based, for the most part, upon the IRS “hurdle” rate, the rate set by the IRS according to I.R.C. § 7520. The current rate is less than two percent.
At the end of the annuity period, the value of the appreciation and income exceeding the hurdle rate will pass to the GRAT beneficiaries (or to trusts for their benefit), free of transfer tax. The key to a GRAT is the current, low interest rate scenario. When the hurdle rate is low, it is easier to have a successful GRAT.
Generally speaking, an ideal GRAT asset is anything that is likely to generate a greater return than the IRS hurdle rate. In many cases, the investor may be able to achieve substantial benefits by transferring either a closely held business interest or real estate to the GRAT. Business experts say that a GRAT may be the ideal estate planning device for such a transfer to your children, since you may be in a unique position to predict the future growth of your own business or real estate assets.
The attorneys at Romano & Sumner have more than 20 years of combined experience providing expert legal assistance to clients in all types of wealth management and estate planning. We have developed many successful estate plans. We have used many types of investment vehicles, including various forms of grantor trusts in order to meet the specific and unique needs of our clients. At Romano & Sumner, we pride ourselves not only upon our professionalism, but also upon our client service. We know that each wealth management/estate planning situation is unique. We keep clients informed. We complete the work within the allotted time frame. We return your calls within 24 hours. We’re ready to assist you as you make the important decisions that affect your family and your honored institutions. Call us at 281-242-0995 or complete our online contact form.
Romano & Sumner, PLLC