Bloomberg BNA's recent article, "Future of Popular Estate-Planning Tool May Hinge on Election," discusses the grantor retained annuity trust (GRAT), which has been successfully used by several of the wealthiest people in America. With a GRAT, assets that are expected to appreciate are transferred to the trust for a retained annuity plus interest to the grantor over the term of arrangement. When the trust expires, any remaining assets left after the annuity is paid are given to the beneficiaries tax-free. For transfer tax valuation purposes, the value of the taxable gift is the fair market value of the property transferred with the value of the grantor's retained annuity interest subtracted.
President Obama has been pushing to modify the transfer tax rules for GRATs in his annual budget proposals since 2010. Earlier proposals called for requiring a minimum term for GRATs, but the most recent proposals have included additional changes.
If Democratic front-runner Hillary Clinton wins, experts think many of her policies will be in line with the Obama administration, like the estate tax. Clinton says she wants to restore the parameters that were in place in 2009, which would reduce the tax exemption threshold for estates to $3.5 million and $7 million for a married couple. There would be no adjustment for future inflation, and the top tax rate would be increased from 40% today to 45%. A Clinton administration may advocate for limiting GRATs. But unless there's a Democratic-controlled Congress, those changes won't occur.
If presumptive Republican presidential nominee Donald Trump wins the election, the proposals on GRATs would go away because Trump's tax plan would repeal the estate tax and remove restrictions on GRATs.
In addition to the recent budget proposals, rising interest rates could also affect the viability of GRATs in the long term. With lower interest rates, the property transferred to the GRAT doesn't have to appreciate as much as it would with higher interest rates for the GRAT to be a successful method of transferring wealth to remainder beneficiaries.
In a grantor retained annuity trust, if the assets produce a return in excess of the tax code Section 7520 rate, the increase in value above the rate is the responsibility of the beneficiaries. The IRS defines the Section 7520 interest rate as 120% of the applicable federal midterm rate, compounded annually. Typically, as interest rates increase, the ability to effectively execute a successful GRAT decreases. That's because the Section 7520 rate that the investments need to exceed is greater. Over time, when interest rates go up to 2 to 4%, it'll eventually diminish the effectiveness of the GRAT.
GRATs are sophisticated estate planning tools. Be sure to secure the help of an experienced estate planning attorney to determine if this is right for your situation.
Reference: Bloomberg BNA (May 31, 2016) "Future of Popular Estate-Planning Tool May Hinge on Election"