A GRAT, or Grantor Retained Annuity Trust, is an advanced estate planning strategy designed to transfer appreciating assets to heirs while minimizing gift and estate taxes.
GRATs are commonly used in high-net-worth estate planning, particularly when someone owns assets expected to grow significantly in value — such as business interests, real estate, or investment portfolios.
How Does a GRAT Work?
A GRAT is an irrevocable trust that works in three main steps:
1. The Grantor Transfers Assets Into the Trust
The person creating the trust (the “grantor”) places assets into the GRAT.
These assets are typically expected to increase in value over time.
2. The Grantor Receives Annuity Payments
For a set number of years, the GRAT pays the grantor a fixed annual payment (called an annuity).
The annuity amount is calculated using IRS guidelines and an assumed interest rate (known as the Section 7520 rate).
3. Remaining Assets Pass to Beneficiaries
At the end of the GRAT term:
- Any remaining assets (including growth above the IRS assumed rate) pass to beneficiaries.
- That transfer can occur with little or no additional gift tax.
If the assets outperform the IRS interest rate, the excess growth passes tax-efficiently to heirs.
Why Are GRATs Used?
GRATs are designed to shift future appreciation out of a person’s taxable estate.
The strategy works best when:
- Asset values are temporarily depressed
- The assets are expected to appreciate significantly
- Interest rates are relatively low
The greater the asset growth during the GRAT term, the more wealth can pass to beneficiaries tax-efficiently.
What Is a “Zeroed-Out GRAT”?
Many GRATs are structured as “zeroed-out” GRATs.
This means:
- The annuity payments are calculated so the taxable gift is close to zero.
- The strategy relies on asset growth exceeding the IRS assumed rate.
This reduces upfront gift tax exposure.
What Happens If the Grantor Dies During the GRAT Term?
This is an important consideration.
If the grantor passes away before the GRAT term ends:
- Some or all of the trust assets may be included in the grantor’s estate.
- The tax benefits may be reduced or lost.
Because of this, GRATs are often structured with shorter terms.
Advantages of a GRAT
- Transfers appreciation with minimal gift tax
- Reduces estate tax exposure
- Retains income stream for the grantor
- Flexible structuring options
- Effective for closely held business interests
Potential Drawbacks
- Irrevocable once created
- Requires careful tax calculations
- No benefit if assets fail to outperform IRS rate
- Estate inclusion risk if grantor dies during term
- Legal and administrative costs
GRATs are sophisticated tools and must be structured properly.
Who Should Consider a GRAT?
A GRAT may be appropriate for individuals who:
- Have significant taxable estates
- Own rapidly appreciating assets
- Are comfortable with irrevocable planning
- Want to transfer wealth during their lifetime
It is not typically necessary for modest estates or simple estate plans.
The Bottom Line
A Grantor Retained Annuity Trust (GRAT) can be a powerful estate planning strategy to transfer wealth efficiently while retaining income during the trust term.
Because GRATs involve complex tax rules and precise structuring, they should only be created with experienced estate planning counsel.
If you are exploring advanced strategies to reduce estate taxes and preserve wealth for future generations, a GRAT may be worth discussing as part of your overall estate plan.
