How Wealthy Clients Can Save on Taxes with GRATs

The down equity market brought on by the COVID-19 pandemic plus rock-bottom interest rates have combined to make grantor retained annuity trusts (GRATs) a very attractive way that wealthy clients can save on federal estate and gift taxes.

“There are a lot of planning discussions going on because of the market volatility, but also because clients are concerned about the economy and their overall health,” said Carin L. Pai, CFA, executive vice president and head of portfolio management and equity strategy for Fiduciary Trust International, which is owned by Franklin Templeton.

Wealthy clients tend to be older. Because the COVID-19 virus has more severe consequences for older people, especially those with pre-existing conditions, such clients have become even more aware of having their estate plans in order and making sure they reflect their goals, Pai observed in a recent interview.

A big advantage of a GRAT is that the appreciation of investments moved into them are no longer subject to federal estate and gift taxes. “Estates with assets exceeding the federal estate tax exemption are subject to a 40% tax rate, so GRATs can be attractive to wealthy people who want to reduce the amount of assets that would be subject to it,” Pai said. In 2020, an individual’s estate is subject to federal estate tax to the extent it exceeds $11.58 million, or about $23 million per couple.

Low-basis stock or concentrated positions are often good investments to consider for a GRAT. The grantor receives annuity payments during the GRAT’s term that are based on an included asset’s original cost basis plus the IRS Section 7520 rate, often referred to as the applicable federal rate (AFR), which was 0.8% in May. The beneficiaries receive any appreciation on the assets, net of the AFR, estate and gift tax free.

In down markets when interest rates are low, the annuity that grantors must take during the GRAT’s term will be smaller. “Any appreciation in excess of that interest rate determined by the IRS – we call it the hurdle rate – can be passed on to children or grandchildren or whomever the beneficiaries are. So that’s a really attractive tool that we are talking to clients about,” Pai said.