Member Article

For the last several months, local and national economies have struggled due to the COVID-19 pandemic. To mitigate the downturn, the federal government reduced interest rates to near zero. This reduced rate has created a unique estate planning opportunity for individuals who hold assets they expect will appreciate, who wish to make lifetime gifts to their lineal descendants, and who wish to make such gifts without incurring annual or lifetime gift tax liability.

Lifetime gifts made to any person in excess of the annual gift tax exclusion amount ($15,000 per recipient in 2020) reduce a person’s lifetime gift and estate tax exemption. Currently, the lifetime gift and estate tax exemption per person is $11,580,000, but this exemption amount is set to reduce to $5,000,000 (as adjusted for inflation) per person in 2026. If a person’s estate exceeds the lifetime exemption amount, such excess would be taxed at a rate of 40 percent. Those who desire to make lifetime gifts to children or grandchildren in excess of the annual exclusion, without reducing the lifetime exemption, may complete gifting through a Grantor Retained Annuity Trust (GRAT).

A GRAT is a form of trust in which the grantor, the person funding the trust, receives annuity payments from the GRAT over a set period of time. Although GRATs must exist for two years, many GRATs exist for five years or more. The annuity amount must return the value of the initial gift plus an additional amount based on the rate set by the IRS under Internal Revenue Code Section 7520 for the month of contribution (the 7520 rate). Any excess appreciation remaining after all annuity payments are made is distributed to, or held in trust for, the grantor’s chosen descendants. Because the GRAT must return the entire gift the grantor makes to the GRAT, such gift does not use any gift or estate tax exemption. Furthermore, the appreciated value in excess of the 7520 rate passes on to the grantor’s descendants without regard to the annual gift tax exclusion amount or lifetime gift and estate tax exemption amounts.

Since the grantor does not use any of his or her estate or gift tax exemption in creating and funding the GRAT, if the GRAT is unsuccessful—that is, the asset does not appreciate enough to clear 7520 rate—the grantor will merely receive the entire asset transferred back from the GRAT and will not have wasted the exemption. If the transferor dies during the GRAT term, his or her estate will receive the assets back and, once again, will not have wasted any exemption on the transfer. This makes for a “heads you win, tails you’re even” type scenario.

While interest rates are particularly low, the impact of a GRAT is magnified. In September and October, the 7520 rate is set to 0.4 percent. Any appreciation beyond 0.4 percent would be distributed to the GRAT’s beneficiaries without reducing the grantor’s lifetime gift and estate tax exemption or the annual gift tax exemption. As a point of comparison, the 7520 rate from January 2017 to February 2020 was often between 2.0 and 3.6 percent. With the current 7520 rate so low, this is a unique opportunity to make lifetime gifts to loved ones while avoiding gift tax liability. However, this sort of planning is time-sensitive. As the economy recovers and the federal interest rate creeps back up, the unique benefit provided by a GRAT will begin to diminish. Now is the time to apply the use of a GRAT to take advantage of this historically unique economic environment to transfer wealth to loved ones while avoiding a reduction in your lifetime gift and estate tax exemptions.