When you are planning your estate you want to be cognizant of all of your options. There are many different estate planning vehicles that can be utilized to address certain situations, and this is why it is advisable to work with a professional. When an experienced estate planning attorney absorbs what you are trying to accomplish and then examines your holdings a strategy will immediately start to coalesce in his or her mind. And since we are talking about advanced tax savings strategies involving specific legal instruments, this strategy is invariably going to include a healthy dose of acronyms. One of them is the GRAT.
GRAT stands for “grantor retained annuity trust.” This vehicle is useful when you would like to derive income from assets that you expect to appreciate and then pass that appreciation on to an heir in a tax-free manner. This is done through what is called the “zeroed out” GRAT strategy. The first thing that you do is fund the trust with volatile assets that you would expect to appreciate significantly. Of course you name a trustee and a beneficiary. When you are drawing up the trust agreement you set a term during which you will be receiving annuity payments out of the trust and the amount of these payments. It should be noted that if you die before the term has ended the strategy fails and the assets are returned to your estate.
When you funded the trust you removed those assets from your estate for estate tax purposes, but that donation is subject to the gift tax. The IRS calculates the taxable value of the gift. You “zero out” the trust by setting your annuity payments to equal this taxable value, so no gift tax is levied. But if the actual appreciation exceeds the original IRS valuation (something you anticipate), your beneficiary receives that remainder free of taxation at the completion of the trust term.
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