Grantor Retained Annuity Trusts

A Grantor Retained Annuity Trust (GRAT) is an advanced estate planning tool sanctioned by the IRS. GRATs are a great vehicle to benefit both you and your heirs. With a GRAT, you typically put an investment asset in this trust. Your heirs receive the investment earnings, and you receive the principal back, all while avoiding any gift tax consequences. Like loans, GRATs mature after a number of years.

GRATs are grantor trusts. As such, they allow you to pay capita -gains and income taxes on the investments in the GRAT on behalf of your heirs. Because the IRS doesn’t consider such tax payments a gift, they are another way to transfer wealth to the next generation free of gift and estate taxes.

But there are drawbacks. Because GRATs have to pay you higher rates than short-term and medium-term family loans, they pass along slightly less to your heirs. The biggest risk is that you might die before your trust ends. In that situation, it’s as if the GRAT never existed: Its entire value — including returns — is generally included in your estate and subject to tax.