Investment growth becomes a tax-free gift to heirs
As the US stock market sinks to lows not seen in years, investors, analysts, and advisors reach for smart solutions to keep their money working for them. For some, grantor-retained annuity trusts (GRATs) may provide one piece of the puzzle.
Grantor-retained annuity trusts are used to shift investment growth out of an estate to its heirs tax-free, while paying the estate owner an annuity. Assets like stocks are put in a privately held business within the trust for a specified time, like two, five or 10 years. When the time is up, any investment growth passes to beneficiaries tax-free and the owner gets back the principal. If there is no growth, the asset simply passes back to the owner without a transfer of wealth.
Five conditions make the most of the GRATs strategy:
The current market conditions must allow for investment growth over the next few years
The S&P 500, a barometer of U.S. stocks, is down about 24% year to date — making it a ripe time to consider a GRAT. Stocks that are expected to regain and exceed their recent value are prime targets for a GRAT. Advisors are recommending their clients position themselves to take advantage of the eventual market rebound, expected by most analysts within the next two to three years.
Most of the estate value is in stocks
Stocks are where the biggest growth potential is, making them the most promising for the GRAT strategy.
You want your heirs to pay less taxes on your gifts
The GRAT helps the heirs of the estate receive money tax-free, rather than paying federal, and possibly state estate taxes. Twelve states plus Washington, D.C., have various, additional state-level estate taxes.
Estate worth $12 million; potentially half of that in 2026
In 2022, there is a 40% tax on estates of $12.06 million or more (double that for married couples) With the GRAT, all gifts up to that amount are tax free for non-spouse beneficiaries during life or at your death.
The estate-tax threshold is scheduled to be cut in half starting in 2026, unless an extension is enacted from Congress, meaning that individuals with a roughly $6 million estate (or $12 million for married couples) may take advantage of the tax-free gifts of investment income.
Growth must exceed the IRS Section 7520 interest rate
The IRS posts a new Section 7520 interest rate each month, which is tied to the Federal Reserve’s benchmark rate. As the Fed raises the interest rate, the 7520 rate goes up as well. For example, in January 2022, the 7520 rate was 1.6; in October it is 4.0.
For the GRAT to work, the investment return rate must be higher than the Section 7520 interest rate. If a GRAT was established in January 2022 at the 1.6% rate, investment income of 5% would result in 3.4% earnings. But, the same GRAT established in October, with the section 7520 rate at 4.0%, would have a return of just 1%.
Be aware that GRAT laws can change. Legislation has been proposed, but not passed, that could:
- Extend the minimum of the GRAT term to 10 years
- Require a minimum amount be left in the estate, rather than attempt to ‘zero out’ the account
- Enact new taxes for asset substitutions
- Eliminate the estate owner’s ability to pay the lower taxes for personal income, rather than the higher rate for estate income
The views expressed in this article are not to be construed as personal advice. You should contact a qualified and ideally regulated adviser in order to obtain up to date personal advice with regard to your own personal circumstances. If you do not then you are acting under your own authority and deemed “execution only”. The author does not accept any liability for people acting without personalised advice, who base a decision on views expressed in this generic article. Where this article is dated then it is based on legislation as of the date. Legislation changes but articles are rarely updated, although sometimes a new article is written; so, please check for later articles or changes in legislation on official government websites, as this article should not be relied on in isolation.
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