GRATs and GRUTs

In this post, I discuss grantor retained annuity trusts (GRATs), grantor retained unitrusts (GRUTs), and their potential estate planning benefits.

*Photo by stopnlook is licensed under CC 2.0. *

In a previous post, I discussed grantor retained income trusts, or GRITs. In this post, I will discuss related types of trusts that can also serve as valuable estate-planning tools: grantor retained annuity trusts and grantor retained unitrusts, or GRATs and GRUTs. These are irrevocable trusts more common than GRITs.

Nature of GRATs and GRUTs

GRATs and GRUTs allow the settlor of the trust to transfer property into the trust and retain either an annuity interest—GRATs—or a unitrust interest—GRUTs. (An annuity interest provides payment of a fixed annuity, such as $10,000 per year, whereas a unitrust interest provides a payment equal to a percentage of the trust value, such as 5% of the trust’s value per year.) Distributions are not merely made of the trust’s income. If the trust’s income cannot meet the annuity or unitrust obligations, the trust’s principal must be utilized.

These trusts may be set up for a fixed term of up to 20 years. When the trust terminates, the assets remaining in the trust will be paid out to the final beneficiaries of the trust.

If you recall from my previous post, a major limitation of GRITs is their inability to name children or a spouse as a beneficiary. Neither GRATs nor GRUTs face this limitation, and so come with a significant additional advantage.

Interactions with the Estate and Gift Tax

Just like GRITs, GRATs and GRUTs are valuable tools to lower eventual estate and gift tax liabilities. The value of the gift is usually less than the value that an outright gift would hold, thereby lowering your gift tax bill while removing the property from your estate.

As with GRITs, however, the value of the trust property is only excluded from your estate if you survive the term of the trust. Consequently, if you die before the trust expires, the trust’s property will be included in your estate and subject to the estate tax. So, there is a balance of considerations when setting up these types of trusts, as you may want to keep the income from the trust as long as possible, but you do not want the trust to outlive you.

Rolling GRATs seek to address this problem. Rolling GRATs are a series of GRATs set up with each GRAT owning a smaller amount of property with the trusts having staggering terms. This helps lowers the risk that you will outlive the trust and thereby keep all the property in your estate, while also lowering the risk that the trust will expire prior to your being ready to lose its distributions.

Choosing Between the Two

If you believe either a GRAT or a GRUT would be a good fit in your estate plan, you may need to choose between the two. GRATs offer more certainty, as the amount distributed is fixed and predictable. The distributions from GRUTs, however, have the potential to increase every year—though they have the potential to decrease as well. In addition, GRUTs do not face the same risk of running out of property prior to the expiration of the trust.

One advantage that a GRUT has over a GRAT that is worth considering is the GRUT’s ability to accept additional contributions. GRATs do not share this benefit. Determining which type of trust is right for you, however, can be a complex matter and should be discussed with competent legal or tax counsel.

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See Also:

Grantor Trusts

Grantor Retained Income Trusts (GRITs)