Depending on the exact nature of your assets and the totality of your wishes there are a number of different financial instruments that can be utilized to great advantage when you are planning for your retirement years and the ultimate distribution of your estate after you pass away. Some of these are quite elegant in the way that they can achieve multiple objectives at the same time, and the grantor retained annuity trust or GRAT would certainly fit this description.
When you fund a grantor retained annuity trust the idea is to use highly volatile assets that you would expect to increase significantly in value over the trust term. You appoint a trustee and name a beneficiary as you would with any trust, and it should be noted that the beneficiary of the GRAT must be a family member. When you create the trust you are removing those assets from your estate and gaining estate tax efficiency in the process, but this action does constitute a taxable gift in the eyes of the IRS.
The taxable value of the gift is calculated using 120% of the federal midterm rate to estimate expected appreciation. The way that the strategy works is that you “zero out” the GRAT by taking annuity payments over the term of the trust that equal its entire taxable value. Since you as the donor are retaining all of the interest there is no gift tax due.
To this point the creation of the GRAT has decreased your estate tax exposure while providing you with an ongoing source of income. The strategy becomes completely successful when the assets in the trust appreciate beyond the original IRS estimate. Should this take place, there will be a remainder in the trust, and ownership of this remainder would pass to your named beneficiary free of the gift tax.
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