When you are planning for your retirement and shaping your ultimate legacy, the exact nature of your assets and your own intentions will have a lot to do with how best to position them. For people who are looking for a way to reduce the taxable value of their estate while using volatile assets as a source of ongoing income the grantor retained annuity trust or GRAT is something to take into serious consideration.
The strategy that we would like to take a look at here is the “zeroed out” grantor retained annuity trust, and here’s how it works You fund the trust with volatile assets that you would expect to appreciate considerably over the term of the trust. You will be receiving annuity payments throughout the trust term, but you name a beneficiary who would receive any funds that were left in the trust should there be any remainder at the end of the term.
By funding the trust with these highly appreciable assets you’re reducing the overall value of your estate and in the process gaining estate tax efficiency while eliminating a possible capital gains burden. There is the gift tax to contend with, and the Internal Revenue Service will evaluate the gift using 120% of the federal midterm rate that was in place during the month of the trust’s creation to account for anticipated appreciation. But when you set up the annuity payments you do the math and make them equal all of the taxable value of the trust so no gift tax is due. This is what is known as “zeroing out” the GRAT.
At the end of the trust term, if the assets did in fact appreciate beyond the original IRS estimate there will be funds remaining. This remainder is then passed on to the beneficiary that you named when you created the trust, and no gift tax is due on this exchange.