GRATS Presented by: Michael W. Halloran CFP ®, AEP, ChFC ®, CLU ® March 4, 2008 The Estate Planning Council of the Fun Coast Palm Coast, Florida

Grantor-Retained Annuity Trust  What is a GRAT?  A GRAT is an irrevocable trust in which the grantor can transfer property to a beneficiary at a reduced gift tax cost while retaining an annual annuity for life (or the joint lives of the grantor and others) or for a term of years.

Grantor-Retained Annuity Trust  Why create a GRAT?  The grantor retains an interest in the trust property, the grantor’s gift is the fair market value of the property transferred, less the present value of the retained annuity payments.

An estate owner may use the GRAT to transfer assets and future appreciation to his or her children. Parent transfers remainder interest in an asset to trust Grantor (parent) Parent retains right to receive a Fixed payment (at least annually) for 10 years. GRAT Irrevocable trust

At the end of the designated time period, the remainder passes to the grantor’s children.

Annual Payment to the Grantor First-Year Payment as a Percentage of the Asset Value of the Retained Interest Gift Tax Value of the Remainder Interest $30,0006%$243,327$256,673 $40,0008%$324,436$175,564 $50,00010%$405,545$94,455 $60,00012%$486,654$13,346 The value of the transferred asset minus the value of the retained annuity interest will equal the value of the remainder interest that is subject to gift taxation. Assumptions: Value of asset placed in GRAT: $500,000 Age of grantor: 65 Type of payment: End of year Term of payment: 10 years Federal discount rate (changes monthly): 4.0%

When is a GRATs use indicated?  Where the client is single and has a substantial estate which federal estate taxes are certain to be paid.  A wealthy widows or widowers, divorced individuals, or other unmarried persons can use as a “marital deduction substitute.  A married couple with an estate in excess of the couples combined unified credit equivalent, can use a GRAT to eliminate or reduce taxes on the death of the second spouse to die.  Protects assets from a will contest, public scrutiny, or election against the will if the grantor survives the trust term.

When is a GRATs use indicated?  As an alternative to a recapitalization or other freezing technique that has the added advantages of gift tax leverage and possible estate tax savings.  When the client will outlive the trust term that is needed to obtain a low present value gift to the remainder person.  The clients assets are so substantial that a significant portion can be committed to a remainder person without compromising his own personal financial security.  When the client has a high risk tolerance and a strong incentive to achieve gift and estate tax savings.

Requirements  An irrevocable trust must be established.  Evidence should be obtained of the value of the assets placed in the GRAT.  The grantor should be given a mandatory annuity or unitrust interest.  The grantor should be given ONLY the annuity or unitrust interest.  Not a requirement but the trustee should be someone other than the grantor or the grantor’s spouse, especially after the grantor’s retained interest has ended.

A 61 year-old affluent individual creates a 10-year GRAT with an annuity payout of 13.33%. The individual’s property, valued at $2,297,320 is gifted to the GRAT The individual’s property, valued at $2,297,320 is gifted to the GRAT The property earns an annual income of 3% The property earns an annual income of 3% The property’s value grows at a rate of 10.18% The property’s value grows at a rate of 10.18% The IRC Section 7520 discount rate is 5.6% The IRC Section 7520 discount rate is 5.6% The individual has an estate tax liability of $20 million. The individual has an estate tax liability of $20 million.

Economic Schedule YearBeginningPrincipal10.18%Growth 3% Annual IncomeAnnualPaymentRemainder 1$2,297,320.00$233,867.18$72,427.61$306,243.78$2,297, $2,297,371.01$233,872.37$72,429.22$306,243.78$2,297, $2,297,428.82$233,878.25$72,431.04$306,243.78$2,297, $2,297,494.33$233,884.92$72,433.10$306,243.78$2,297, $2,297,568.57$233,892.48$72,435.44$306,243.78$2,297, $2,297,652.71$233,901.05$72,438.10$306,243.78$2,297, $2,297,748.08$233,901.75$72,441.10$306,243.78$2,297, $2,297,856.15$233,921.76$72,444.51$306,243.78$2,297, $2,297,978.64$233,934.23$72,448.37$306,243.78$2,298, $2,298,117.46$233,948.36$72,452.75$306,243.78$2,298, Summary$2,297,320.00$2,339,011.35$724,381.24$3,062,437.80$2,298, Most people would gladly choose to pay $229,732 in premiums rather than the full $20 million in estate tax.

Tax Implications  If the grantor outlives the specified term, none of the trust’s assets should be included in the grantor’s estate. This is because the grantor has retained no interest in trust assets at death.  The gift to the remainder person is a gift of a future interest. It cannot qualify for the gift tax annual exclusion.  If the grantor lives beyond the specified term, there should be no further transfer tax since the gift was complete upon the funding of the trust.  The taxable portion of post- ’76 gifts is considered an “adjusted taxable gift”.

Tax Implications  At the grantor’s death beyond the specified term of years, no step-up in basis for the property will be allowed. Instead, basis is fractionalized.  If the grantor dies before the specified term expires, the date of death value of the property will be includable in the grantor’s gross estate.  If appreciated property is transferred the tax on any gain will eventually be paid by (a) the grantor, or (b) the trust, or © the beneficiaries.  GRATs are generally subject to IRC Section 2702.

Section 2702  States that all retained interests in trusts that are not “qualified interests” are values at zero.  The amount of any gift is then determined by subtracting from the value of the property the value of the retained interest.  Those that do not apply: Personal residence trusts Charitable remainder annuity trusts and pooled income funds Charitable lead trusts Certain charitable remainder unitrusts

Section 2702 Interest  Qualified interests are valued under IRC Section 7520  Example: at approx. 120% of the applicable federal midterm interest rate under IRC Section 1274(d)(1) for the month into which the valution falls.  A Qualified interest is:  A qualified annuity interest  A qualified unitrust  A qualified remainder interest  Section 2702 Rate is 3.6% - for March 2008

Section 2702  What applies under Section 2702?  A member of the family includes the spouse of an individual, ancestor, lineal descendant, or the individual’s spouse, the brother or sister, and the spouse of any such person.  An applicable family member includes the spouse of an individual, the ancestor of the individual, or the individual’s spouse, and the spouse of any such person  A transfer in trust includes a transfer to a new trust or existing trust or assignment of an interest in an existing trust, but not a transfer resulting from exercise of a power of appointment that would constitute a taxable gift or a disclaimer.  The retained interest is one held by the same individual both before and after the transfer to the trust.

Advantages / Disadvantage Gift taxes are based on the value of the gift to the donee and a gift must be “discounted” by the cost of waiting. Gift taxes are based on the value of the gift to the donee and a gift must be “discounted” by the cost of waiting. Once the grantor lives longer than the specified term, he neither owns the property in the trust nor any rights thereto. It escapes estate taxation. Once the grantor lives longer than the specified term, he neither owns the property in the trust nor any rights thereto. It escapes estate taxation. If the client dies during the specified term, the result is that the property plus any appreciation will be includable in his estate (same result as if the client had done nothing). If the client dies during the specified term, the result is that the property plus any appreciation will be includable in his estate (same result as if the client had done nothing). Attorney fees and other transaction costs, such as appraisal fees and property titling costs. If the grantor does die during the specified trust term, his executor may be liable for tax on the includable assets – the property itself might not be available to pay the tax. Lost opportunity cost. A GRAT is an irrevocable trust.