"As the continuing threat of the novel coronavirus steadily sinks the United States economy towards recession, higher net worth taxpayers have been presented with an environment ideal for shifting appreciable wealth at a potentially steep discount.
The grantor retained annuity trust, commonly referred to as a “GRAT”, is a common estate tax planning technique that is most effective during economic downturns and low Federal interest rate environments. The concept behind the GRAT is relatively simple. An individual (the “Grantor”) transfers assets to an irrevocable trust in exchange for an annuity, payable for a specified term of years. The annuity is equal to the value of the assets contributed to the GRAT, plus interest. At the expiration of the annuity term, the remaining assets in the GRAT are transferred to the beneficiaries of the GRAT, usually the Grantor’s younger generation family members, and are no longer part of the Grantor’s taxable estate.
The estate and gift tax savings opportunity that a GRAT provides arises from the fact that the IRS determines the minimum interest rate required for the annuity payments paid back to the Grantor. The IRS rate is called the 7520 rate and it is often substantially lower than the actual appreciation of the underlying assets. The 7520 rate in effect for the GRAT is the rate for the month in which the assets are contributed to the GRAT; the interest rate does not fluctuate during the term of the GRAT. If the interest rate for the annuity payments is equal to the applicable 7520 rate, then value of the gift contributed to the GRAT for gift tax purposes is zero, even if the underlying assets appreciate at a rate higher than the applicable 7520 rate.
For example, if you contributed assets that are set to appreciate at 8% per year to a GRAT in May of 2018, when the 7520 rate was 3.2%, you would be required to receive annuity payments back plus 3.2% per year to value the gift at zero. The remaining 4.8% growth remains in the GRAT, and because the annuity payments are fixed, the longer the GRAT continues, the more the underlying assets will benefit from compound interest.
Furthermore, there is no requirement that the annuity payments be equal to the value of the assets contributed plus the applicable 7520 rate. Any difference, however, utilizes the Grantor’s $11.58 million estate and gift tax unified exemption amount. This is not, however, a bad thing. Because the taxable gift is offset by the annuity payments, the Grantor can work with his or her attorney to calculate the portion of his or her unified exemption that, if used to offset the gift tax amount, will potentially shift to the GRAT substantially more than just the difference between the 7520 rate and the growth of the asset.
So why is 2020 a near perfect environment for a GRAT? First, after nearly 10 years of straight growth, the stock markets have seen a drastic drop in value. An investment portfolio in marketable securities worth $10 million a year ago may only be worth $8 million now. Because the markets inevitably seem to recover, contributing marketable securities to a GRAT when they are at their lowest in years may be a great way to shift appreciation. In effect, you get to value a potential $10 million asset at $8 million before you even begin applying the GRAT calculation.
Secondly, the 7520 rate for May 2020 is at the lowest in over two decades, 0.8%. For the example above, this means that a Grantor would shift 7.2% growth estate and gift tax free instead of 4.8%, due to the historically low 7520 rate. For reference, the May 2019 7520 rate was 2.8% and the May 2017 rate was 2.4%. Even in the heart of the post-2008 recession, the 7520 rate never dropped below 1.0%. Simply put, this is the lowest 7520 rate in decades.
Because the 7520 rate fluctuates each month, it is best to implement the GRAT strategy sooner rather than later. If you have any questions regarding GRATs or estate planning in general, please contact me at andrew.bell@sfnr.com."
Andrew D. Bell, Associate
Schoenberg Finkel Newman & Rosenberg, LLC
Andrew Bell is a tax, estate planning and transaction attorney. He assists closely held business clients with their succession planning, provides tax analysis as part of the firm’s transaction practice, prepares estate and gift tax returns, handles the probate of decedents’ estates, and maintains a sophisticated corporate practice. He also participates in the Wills for Heroes program, providing wills and powers of attorney to first responders without charge. Andrew is licensed in both Illinois and Michigan.
AREA OF LEGAL CONCENTRATION
Andrew concentrates his practice in the areas of estate and tax planning, asset protection planning, business succession planning, corporate transactions, and probate and trust administration. He has drafted and implemented a variety of estate planning techniques, including wills, powers of attorney, and grantor and non-grantor trusts. Andrew regularly works with his closely held business clients to effectuate transitions from one generation to the next, leveraging his tax and estate planning background to achieve cost-effective strategies.
Professional Memberships
• Chicago Bar Association
Bar Admissions
• Illinois
• United States District Court for the Northern District of Illinois
• Michigan
Education
• J.D., Loyola University Chicago School of Law
• LLM, Tax Loyola University Chicago School of Law
• B.A., Michigan State University.
Waddell & Reed is not affiliated with Andrew Bell or Schoenberg Finkel Newman & Rosenberg, LLC, or any other entities referenced. Mr. Bell's comments do not necessarily reflect those of Waddell & Reed. The information presented is for educational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results. We believe it to be reliable, but it is not guaranteed by Waddell & Reed, Inc. as to the accuracy and is not intended to be used as the basis for any investment decisions. Please consult your financial advisors before making financial decisions. Waddell & Reed and its representatives do not offer tax or legal advice. (05/20)