What is a Grantor Retained Annuity Trust [GRAT]

A Grantor Retained Annuity Trust or "GRAT" is a trust used to assist with the transfer of assets to the next generation with lower gift tax rates. The grantor sets up a GRAT with an established termination date. During that time, the trustee distributes a specific amount of trust assets to the grantor as mandated by the trust [e.g. monthly, yearly].

When the trust ends, the trustee distributes remaining assets to beneficiaries who are usually the grantor's children or create a trust for the grantor's children. When the grantor funds the trust, he/she is making a taxable gift. The value of the gift, is reduced by the value of the interest the grantor maintains in the trust -- the retained annuity interest.

The larger the retained annuity interest, the more the value of the taxable gift is reduced at the funding of the GRAT. This tactic may be more successful when interest rates are low, the value of the grantor's retained annuity interest is higher, reducing the value of the gift.

The GRAT tactic works well when the assets used to fund it have cash flow because the trustee has to distribute the annuity amount outlined in the trust either from other trust assets or income. This tactic can be used even further by gifting assets that can be discounted, e.g. closely held business or family limited partnerships holdings.