GIVE AND YOU SHALL RECEIVE
October 2006
How would you like to give away a portion of your estate and retain the ability to earn income from those assets at the same time? Sound impossible? Well, it's not with the grantor retained trust (GRT).
In a GRT, an individual (grantor) contributes assets to the trust and agrees to receive a dollar amount of income from the trust each year for a fixed amount of time. Whatever is left in the trust when it expires passes to the grantor's heirs . When the GRT is set up, the IRS levies a gift tax on the amount that will eventually be gifted. The gift is the difference between the amount contributed and the present value of the income payments that the grantor will receive. If the grantor outlives the fixed term of the trust, none of the trust assets are included in the grantor's estate.
The net result: a rapidly growing asset can be transferred at a very low transfer tax cost. This results in a significant leveraging of the gift tax credit (currently set at $1 million). Let's look at an example: Let's say a 65 year-old puts $1 million in a trust and agrees to take back a 6% payout over the next 5 years. The value of this payout is currently $257,425. The difference between the $1 million and the payout amount, or $742,575, is the value of the gift. If the grantor outlives the term of the trust, he will have gifted $1 million plus any appreciation on that $1 million over the next five years to his heirs at a gift tax cost of $742,575. A nice discount is achieved!
There are two types of GRTs. The example above shows a GRUT (grantor retained unitrust) under which a percentage of the fair market value of the assets is received annually. In contrast, in a GRAT (grantor retained annuity trust) a fixed amount of money (an annuity) is distributed from the trust each year.
Why is it important to leverage your gift tax exemption? When Congress revised the estate tax rules, raising the unified credit amount to its current level of $2 million and increasing it in the year 2009 to $3.5 million, it left the gift tax exclusion amount untouched at $1 million. It is the holy grail of estate planning to transfer the maximum amount of wealth while minimizing the use of the gift tax exemption available to each taxpayer. An even greater advantage however is the fact that 100% of post gift appreciation in the properties value escapes estate, gift and generation skipping transfer tax.
The important caveat here is that the grantor must outlive the term of the trust. However, the downside risk is minimal since if the grantor dies during the term of the trust, the assets revert to his estate and conditions become as though he never created the GRT. You are in no worse situation than if you have not formed the GRT in the first place.
Who should consider a GRT? The individual who has a high risk-taking propensity and a strong incentive to achieve gift and estate tax savings (rather than taking a safer but more costly approach in making an immediate gift) is a prime candidate. Similarly, a married couple with a large estate can use a GRT to eliminate or reduce taxes on the death of the second spouse to die. A GRT is also useful where a client is single and has a substantial estate upon which federal estate taxes are certain to be paid.
For more information on a GRT and to determine if one would be suitable for you, please contact Diane Burke, (302) 656-6632 or DBurke@CoverRossiter.com .