How to transfer $$ to your Kids Tax Free.
In 2021, Bloomberg reported that billionaire Charles Schwab used a GRAT to transfer $2.7 billion worth of shares in his company, Charles Schwab Corporation, to his heirs tax-free. Schwab created the GRAT in 2010 and transferred the shares into the trust. Over the 10-year term of the trust, Schwab received annuity payments totaling $1.1 billion. However, the value of the shares had grown to $4.3 billion by the end of the trust term, meaning that $2.2 billion in appreciation was transferred to Schwab's heirs tax-free.
This is a prime example of how a GRAT can be used to transfer wealth to heirs while minimizing tax liability. By transferring the shares into the GRAT and receiving annuity payments based on a low interest rate, Schwab was able to minimize the gift tax value of the transfer. Meanwhile, the appreciation in the value of the shares was transferred to his heirs tax-free at the end of the trust term.
It's worth noting that GRATs are a complex estate planning tool that are only suitable for high net worth individuals. As with any estate planning strategy, it's important to consult with a qualified professional before setting up a GRAT to ensure that it's the right approach for your specific situation.
Breaking it Down
Grantor Retained Annuity Trusts (GRATs) are a popular estate planning tool that wealthy individuals use to grow their wealth tax-free. A GRAT is a type of trust that allows the grantor (the person who creates the trust) to transfer assets into the trust and receive an annuity payment for a set period of time. At the end of the trust term, any remaining assets are transferred to the trust beneficiaries, typically the grantor’s children or other family members.
The key advantage of a GRAT is that it allows the grantor to transfer wealth to their beneficiaries while minimizing gift and estate taxes. When assets are transferred into a GRAT, the IRS determines the gift tax value based on the present value of the annuity payments the grantor will receive. If the assets in the trust appreciate at a rate higher than the IRS’s assumed rate, any excess appreciation is transferred tax-free to the beneficiaries.
For example, let’s say that a wealthy individual creates a GRAT and transfers $10 million worth of stock into the trust. The trust is set up to pay the grantor an annuity of $1 million per year for 10 years. The IRS assumes a 1.4% rate of return for the trust assets. If the stock in the trust appreciates at a rate of 6% per year, the grantor would receive a total of $10 million in annuity payments over the 10-year term. However, at the end of the term, the remaining $5.6 million of assets would be transferred to the beneficiaries tax-free.
GRATs can be a powerful tool for wealthy individuals looking to transfer wealth to their heirs while minimizing gift and estate taxes. However, they are not without risks. If the assets in the trust do not appreciate at a rate higher than the IRS’s assumed rate, the trust may not provide any tax benefits. Additionally, if the grantor dies before the end of the trust term, the assets in the trust are included in their estate and subject to estate taxes. As with any estate planning strategy, it is important to consult with a qualified professional before setting up a GRAT.
Tune in next time to learn why the GRAT, while useful, has been eclipsed in many ways by the utility of the Intentionally Defective Grantor Trust (IDGT - pronounced within our profession as idget ).
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