The stock market is roiling, the real estate market is depressed, and businesses are struggling. It may seem like an inopportune time for a dramatic estate-planning move. But this uncertain economic environment could create a “perfect storm” for passing wealth to a younger generation.
 One estate-planning maneuver that may work well now is to establish a grantor retained annuity trust (GRAT). With a GRAT, you transfer property to an irrevocable trust. That property might be stock in a company you own, commercial real estate, or even publicly traded securities. The GRAT makes annuity payments to you during the term of the trust. When the term expires, whatever assets are left (the remainder) pass to the beneficiaries you’ve designated.
The IRS treats the transfer of that remainder interest as a taxable gift. But because no one can say what the value of the assets will be at the end of the trust term, the IRS makes an educated guess. It uses a prescribed interest rate (the “Section 7520” rate) to calculate the growth of the assets, which are reduced by the scheduled annuity payments you receive.
 Although interest rates crept slightly higher during the summer of 2008, they’re still on the low side. The Section 7520 rate is adjusted monthly to reflect prevailing interest rates, and the rate for February 2009, for example, was 2.0%, compared with 6.2% as recently as August 2007. The lower the Section 7520 rate, the smaller the projected GRAT remainder, and the less potential gift tax the GRAT will generate.
For you to come out ahead, the trust assets must appreciate at a rate that’s better, on average, than the IRS interest rate. That may be more likely these days, when asset values are depressed. For example, assume you transfer $1 million in company stock to a GRAT. If you structure the annuity payments so that they cancel out the IRS-projected growth of the assets, the taxable remainder is $1 million, equal to the maximum lifetime gift tax exemption for an individual. So, you won’t owe any tax on the transfer to the GRAT. (Alternatively, you could “zero out” the GRAT and not use your lifetime gift exemption.) But if the company stock gains value so that the actual gift is worth, say, $2.5 million, your beneficiaries will receive an extra $1.5 million without any additional gift tax. That scenario is all the more likely if the value of the assets you transfer to the GRAT is temporarily depressed and may come roaring back when the economy improves.
There are two potential drawbacks. The first occurs if the rate at which the trust assets appreciate ends up being below the IRS Section 7520 rate. Secondly, if you die before the end of the GRAT term, the trust assets revert to your estate and could be subject to estate taxes. But the potential benefit of establishing a GRAT may likely outweigh these risks. |