17 February 2016

Market Turmoil Creates Planning Opportunities

Jeremy B. Crickard
Partner | US

While the state of the stock market may be causing stress for some investors who might otherwise hope to hunker down, ignore the market ups and downs and weather the storm, the current market climate actually presents a planning opportunity for Grantor Retained Annuity Trusts, or GRATs.

An individual creates a GRAT by transferring assets into an irrevocable trust and retains the right to an annuity payment from the trust for a specific period of years. The amount of the annuity payment retained by the grantor is a function of the value of the property contributed to the GRAT, the GRAT's specific term of years and an assumed rate of growth that is set by the federal government on a monthly basis.

So why is now a good time to consider a GRAT? Because one of the key drivers determining the annuity is the initial value of the property contributed to the GRAT, assets which have temporarily decreased in value due to general market conditions, but which an investor believes will eventually increase in value, perhaps dramatically, over the term of the GRAT, will lead to a lower annuity payment upon the property's contribution to the GRAT.

These reduced annuity payments make it easier to structure the GRAT so that the value of the remainder interest, which is considered to be a taxable gift to whoever receives it, is close to or equal to zero. This is referred to as zeroing out a GRAT. But why would someone want to create an irrevocable trust, only to receive back annuity payments equal to value of the property contributed? This is, again, where the currently reduced value of the property contributed to the GRAT is key. As long as the property contributed to the GRAT appreciates as expected when the markets return to normal, the remainder interest in the GRAT will actually be worth more than zero. In other words, rather than having nothing left at the conclusion of the GRAT term, there can be, if all goes according to plan, a significant remainder interest to be distributed to the remainder beneficiaries. The annuity payments themselves can even be structured to help achieve this goal, by designing them to increase over time, so that less money is paid out of the GRAT at the beginning of its term, while more is paid out later. Using this structure allows the GRAT to reinvest its growth early on, which can help to optimize the value of the remainder interest for the remainder beneficiaries.

GRATs have other particular advantages. One is that GRATs are grantor trusts for income tax purposes, which means that grantor of the trust is responsible for the GRAT's income taxes. While this might not sound like an advantage at first, it actually increases a GRAT's ability to transfer family wealth in a tax efficient manner. This is the case because the grantor, through the payment of the GRAT's income taxes, is effectively making tax-free gifts to the trust. A second is that GRATs are actually part of federal tax law, so for individuals who are concerned with being too close to the cutting (or, bleeding) edge with their planning, this often provides additional comfort with the technique.

This does not mean that GRATs are without complexity. Careful consideration must be given to such items as the GRAT's term and the assets used to fund it. However, for people who want to do something other than simply outlast the current storm in the markets, a GRAT may be worth real consideration. If you would like to discuss how you could put this information to use for you and your family, please consult your Withers Bergman attorney.

Jeremy B. Crickard Partner | Rancho Santa Fe, San Diego

Category: Article