March 26, 2020
This is the first in a six-part series that focuses on proactive planning strategies in a volatile market.
Global pandemic fears, plunging stocks, the Fed’s emergency interest rate cut and a steep decline in 10-year Treasury yields wreaked havoc on many investment portfolios in recent weeks.
Regardless of how bleak the situation may appear, low stock prices and rock-bottom interest rates are creating potentially ideal conditions for certain wealth planning strategies. While increased market volatility can be unnerving for even the best investors, times like these can also present opportunities to implement wealth transfer strategies that can generate significant tax savings. One such strategy is the grantor retained annuity trust (GRAT).
Listen to the podcast
A grantor retained annuity trustis a powerful wealth management tool that can be highly effective in both up and down markets. A GRAT allows individuals who have accumulated wealth to transfer some of that wealth to family members in a tax-efficient manner.
In short, a GRAT is an irrevocable trust in which the grantor contributes assets to the trust and retains the right to receive an annual payment (annuity) from the trust for a specific term (usually two to 10 years). Importantly, income produced by the trust is taxable to the grantor, which helps the assets within the trust grow without the burden of income taxes. When the trust term ends, if assets have outperformed the Internal Revenue Service (IRS) hurdle rate (the assumed rate of return) and the trust is properly structured, the excess appreciation is passed on to the trust beneficiaries tax-free—as long as the grantor outlives the trust term.
GRATs generally perform best when funded in rising markets with assets that have the potential to appreciate in value; however, a declining market and low interest rate environment can give assets held in a GRAT more upside potential. If the value of the GRAT’s assets rebounds, most of the appreciation can pass through to beneficiaries with minimal transfer tax consequences.
In order for a GRAT to be successful, trust assets must be able to generate returns above the IRS hurdle rate. The hurdle rate, also known as the 7520 rate, is published monthly by the IRS and is currently set at an ultra-low 1.2% for trusts established in April 2020, down from 2.0% in January. A low interest rate environment makes it more likely that a GRAT’s growth rate will exceed that of the hurdle—which means the GRAT retains all of its tax advantages, and the beneficiaries receive a greater share of appreciated assets tax-free.
GRATs that were funded with assets at a much higher valuation, but have lost tremendous value and are unlikely to recover within the term of the trust, may be in jeopardy of failing. In situations like this, the grantor can substitute poor-performing assets with those that have better growth potential. In addition, in a falling or low interest rate environment, the grantor can use the assets that have lost value to fund a new GRAT at a much lower initial price and with a much better chance of outperforming the hurdle rate.
Even if appreciation is never achieved, or the grantor does not outlive the term of the trust, assets simply flow back to the grantor (or the grantor’s estate) without any adverse tax consequences. If the grantor is still living, the grantor is free to create a new GRAT. As a result, a GRAT is a low-risk gifting strategy.
If assets within a GRAT have appreciated, but there is a chance that market volatility could diminish or erase those gains, it may make sense for a grantor to lock in the GRAT’s appreciated value. The grantor will swap out assets that have risen in value for assets that may be more stable--thereby preserving both the GRAT’s tax benefits and accumulated appreciation in volatile markets.
Rolling GRAT strategies can be particularly effective because of their ability to capture the upside of a volatile market.
A rolling GRAT strategy typically involves the creation of a series of short-term GRATs (generally two to three years). Each successive GRAT is funded by the annuity payments received from previous GRATs. Rolling GRATs “freeze” the grantor’s estate and exclude the appreciation generated by those assets from the estate in an ongoing and incremental basis, without the commitment of a lengthy annuity period.
If you’re interested in learning more about how to incorporate GRATs into your wealth management plan, an experienced tax advisor will be able to help you determine the best approach for your individual circumstances.
For more information on grantor retained annuity trusts and other lifetime gifting strategies, visit our Lifetime Gift Planning resource page.
Proactive Planning During a Time of Uncertainty and Volatility
Part 2: Proactive Planning in Volatile Markets with Roth Conversions
Part 3: Proactive planning with low market values using Spousal Lifetime Access Trusts
Part 4: Proactive planning with low market values using a sale to a Grantor Trust
Part 5: Proactive planning with low interest rates using intra-family loan
Part 6: Proactive planning with low market values using gifts
March 22, 2020
April 08, 2020
April 13, 2020
* Required fields
Internal Custody:If your assets are custodied with Atlantic Trust, please select the internal custody version of Atlantic Trust Portfolio Online to view your portfolio information.
External Custody:If your assets are custodied with an external custodian, such as Schwab, Fidelity or The Bank of New York, you may access the external version of Atlantic Trust Portfolio Online.
Sponsored Funds Investors:If you are an investor in any of the Atlantic Trust Sponsored Funds, you may access the Atlantic Trust Investor Dashboard here.
Safari Browser Users:To access login links, you will need to deselect the "Block pop-up windows" option under your security preferences.
For further assistance, please contact your Atlantic Trust client service team.