What is a Rolling GRAT in New York?

Rolling GRATs involve a strategy of creating a series of short-term GRATs, typically with staggered terms of 2-3 years each. Using short-term GRATs minimizes the risk of the grantor's death during the trust term, while multiple GRATs allow for diversification of assets and timing of transfers.

GRATs

Grantor Retained Annuity Trusts (GRATs) are irrevocable trusts that allow the transfer of assets to beneficiaries while minimizing estate tax liability. Assets placed in a GRAT are removed from the grantor's taxable estate, and beneficiaries receive the assets at the end of the trust term with reduced or eliminated gift and estate taxes. GRATs are commonly used for high-value, appreciating assets such as real estate, business interests, or investment portfolios.

The grantor transfers assets into the trust at their current value and retains the right to receive an annuity payment for a specified number of years using the IRS Section 7520 rate. At the end of the term, the asset is transferred to the designated beneficiaries, who can be individuals, such as children or grandchildren, or other trusts. If the asset appreciates higher than the Section 7520 rate (for example, the Section 7520 rate is 3% and the asset appreciated at 8%), the excess growth is transferred to the beneficiaries, tax-free. This leverage allows substantial wealth transfer while using minimal gift tax exemption. GRATs are particularly effective for assets expected to appreciate significantly, such as pre-IPO stock or real estate in growing markets.

In a GRAT, the grantor selects the trust term, typically between 2-10 years, and the annuity payments can be fixed or increase annually by up to 20%. The grantor pays income taxes on the trust assets, allowing them to grow tax-free for the beneficiaries. If the grantor survives the trust term, the remaining assets pass to the beneficiaries free of gift and estate taxes. However, if the grantor dies during the trust term, a portion of the assets may be included in the taxable estate.

The annuity payment value is determined by the IRS using the Section 7520 rate, which is published monthly and based on 120% of the federal midterm rate. Lower 7520 rates result in lower annuity payments and more assets transferred to the beneficiaries. The annuity payments are calculated using the 7520 rate in effect at the time the GRAT is established.

Rolling GRATs

Rolling GRATs involve a strategy of creating a series of short-term GRATs, typically with staggered terms of 2-3 years each. The grantor establishes multiple GRATs, funding each one with a portion of their assets. Using short-term GRATs minimizes the risk of the grantor's death during the trust term, while multiple GRATs allow for diversification of assets and timing of transfers. As each GRAT term ends, the remaining assets are distributed to the remainder beneficiary, and the grantor receives annuity payments from the expiring GRAT. The grantor then uses a portion of the annuity payments to fund a new GRAT, effectively "rolling" the assets from one GRAT into the next. This process continues for an extended period and can be used to transfer assets over multiple generations. Rolling GRATs allow for the continued transfer of assets to beneficiaries while minimizing estate tax liability. Each GRAT in the series removes a portion of the assets from the grantor's taxable estate, and as the process is repeated, a significant amount of wealth can be transferred tax-efficiently. Rolling GRATs take advantage of the power of compounding to increase the amount of assets transferred and are particularly effective for rapidly appreciating assets or during periods of low interest rates.

The process of creating a rolling GRAT begins with establishing a short-term GRAT with a term of 2-3 years. A shorter term reduces the risk of the grantor's death during the trust term. For example, a grantor may create a 2-year GRAT funded with $1,000,000 in assets. The GRAT is "zeroed out," meaning that the annuity payments are set so that the present value of the payments equals the value of the initial trust assets. This results in a minimal taxable gift, often close to zero, because the IRS assumes the GRAT asset will grow at the Section 7520 rate, and when its growth surpasses this rate, the excess growth transfers to the beneficiaries tax free.

At the end of the term, the GRAT assets are distributed to the remainder beneficiary, which is often an irrevocable trust for the benefit of the grantor's descendants. After the 2-year term, the remaining assets are transferred to an irrevocable trust for the grantor's children. The grantor then "rolls" the assets returned via annuity payments into another GRAT. The grantor receives the annuity payments from the expiring GRAT and uses a portion of these funds to establish a new GRAT.

This process is repeated at the end of each GRAT term, continually removing assets from the grantor's estate. As each GRAT term ends, the process is repeated with the creation of a new GRAT. This cycle of rolling assets from one GRAT to another continues for an extended period. The grantor may repeat the process every 2 years, creating a series of GRATs that gradually transfer wealth to the irrevocable trust while minimizing estate tax liability. The grantor may also stop the rolling process at any time and for any reason, such as needing the income from the trust assets or no longer having an estate tax concern.

Benefits of Rolling GRATs

Rolling GRATs offer several benefits, including the nominal use of gift tax exemption. By setting the annuity payments to "zero out" the GRAT, the taxable gift to the trust is minimal, allowing the grantor to transfer significant assets without using a substantial portion of their lifetime gift tax exemption. Preserving the gift tax exemption allows the grantor to make additional tax-free gifts or transfers in the future, and the grantor can effectively transfer the excess appreciation of the GRAT assets tax-free to the remainder beneficiary.

Another benefit of rolling GRATs is the flexibility in asset selection. GRATs can be funded with a wide variety of assets, including real estate, business interests, stocks, and other investments. The grantor can select assets that are expected to appreciate significantly during the GRAT term. For instance, a grantor can fund a GRAT with pre-IPO stock, anticipating substantial growth in value once the company goes public. Diversification can be achieved by funding multiple GRATs with different asset classes or individual assets. This flexibility allows the grantor to tailor the GRAT strategy to their specific investment portfolio and wealth transfer goals.

During the GRAT term, the grantor retains the use of assets via annuity payments, providing them with a source of income. These annuity payments can be used to maintain the grantor's lifestyle or to fund new GRATs. By retaining the right to receive annuity payments, the grantor maintains some control over the assets transferred to the GRAT, which may be particularly appealing to grantors who are hesitant to relinquish complete control of their assets.

Rolling GRATs also provide protection against market volatility by allowing the grantor to adjust the asset mix and timing of transfers when rolling assets into new trusts. If the assets in a particular GRAT perform poorly, the grantor can choose to fund the next GRAT with different assets or wait for a more favorable market environment. For instance, if a GRAT funded with stocks experiences a market downturn, the grantor can choose to fund the next GRAT with more stable assets, such as bonds or real estate. By continuously rolling assets into new GRATs, the grantor can take advantage of market upswings and minimize the impact of downturns. This strategic approach to asset selection and timing can help optimize the wealth transfer process over the long term.

Establishing a GRAT requires legal and professional fees for drafting the trust document and ensuring compliance with tax laws. The grantor should anticipate costs associated with appraisals, especially for hard-to-value assets like closely-held business interests or real estate. Ongoing administrative costs include annual trust tax return preparation, asset management fees, and potential trustee fees. These costs should be weighed against the potential estate tax savings and wealth transfer benefits provided by the GRAT strategy.

Assessing an individual's financial situation and estate planning goals is a critical step in determining the appropriateness of a rolling GRAT strategy. Navigating complex tax laws and regulations is an essential role of estate attorneys like us in the GRAT process. We can provide guidance on the latest tax laws and regulations affecting GRATs and help ensure that the GRAT is properly structured and administered to minimize the risk of an IRS challenge.

Should you need assistance in establishing a GRAT, you can call the Law Offices of Albert Goodwin at 212-233-1233 or send us an email at [email protected]. We represent GRAT clients throughout the state of New York, including all five boroughs of New York City (Manhattan, Brooklyn, Queens, The Bronx, and Staten Island), Long Island, and Upstate New York.