How To Use Grantor Retained Annuity Trusts to Minimize Taxes

A common question from clients with significant wealth is, “How can I transfer assets to my heirs without losing a large portion to estate or gift taxes?” If that sounds like you, you might benefit from learning more about a strategy known as a Grantor Retained Annuity Trust, or GRAT.

Let’s walk through how GRATs work, why they’re attractive, and when they might make sense for your estate planning.

What is a GRAT?

A Grantor Retained Annuity Trust is an irrevocable trust designed to transfer future appreciation of an asset to your beneficiaries while limiting gift and estate tax exposure. Here’s the basic idea:

• You place appreciating assets (like stock or business interests) into the GRAT.
• You retain the right to receive an annuity (fixed annual payments) for a set number of years.
• At the end of the term, any remaining value in the trust passes to your beneficiaries, free of additional gift tax.

The key benefit? If the assets grow faster than a set interest rate (called the Section 7520 rate), the appreciation passes to your heirs tax-free.

Why use a GRAT?

There are several reasons to consider a GRAT:

Minimizing gift taxes: The value of the gift is calculated using IRS assumptions about future returns. If actual returns are higher, that extra value passes to your beneficiaries with no additional tax.

Safeguarding your estate tax exemption: Because you retain an annuity, the IRS discounts the value of the gift, meaning only the excess (if any) is subject to gift tax.

Efficient transfer of appreciating assets: Assets like technology stocks, private equity, or real estate, which are expected to grow quickly, are ideal for GRATs.

Low IRS hurdle rate: The Section 7520 rate (used to calculate the value of the retained annuity) has been historically low, making GRATs more favorable.

An example

Let’s say you contribute $5 million in stock to a GRAT. You retain the right to receive $1 million annually for five years. At the end of the term, if the assets have grown beyond the value of the annuity payments (plus the IRS’s assumed rate of return), the excess passes to your beneficiaries with no gift tax.

If the IRS assumed rate is 4%, but the assets grow at 9%, your beneficiaries could receive a substantial sum tax-free.

What happens if the assets don’t outperform the IRS rate?

If the assets underperform or you pass away before the GRAT term ends, the trust assets return to your estate. In that case, there’s no transfer to beneficiaries, no tax benefit, and no penalty. You essentially get the assets back. In that case, there’s no transfer to beneficiaries or tax benefit.

This is why GRATs are often structured in short rolling terms (e.g., two years), so if one underperforms, others may succeed.

Zeroed-out GRATs: A clever twist

A popular approach is the “zeroed-out GRAT.” A zeroed-out GRAT is designed so that the present value of the annuity payments matches the value of the asset transferred to the trust. This means that the taxable gift is effectively reduced to zero because the annuity payments are structured so that they equate to the full value of the asset transferred.

Essentially, the grantor receives enough annuity payments to offset the value of the gift, resulting in no immediate tax liability. The key difference between the standard and zeroed-out GRAT is in the annuity structure.

In a standard GRAT, the annuity payments are typically set to give the grantor a certain percentage of the trust’s value each year. This amount is calculated to ensure that the grantor receives enough income to cover the gift’s value while allowing for some appreciation of the trust’s assets that can pass tax-free to beneficiaries.

A zeroed-out GRAT is specifically structured so that the total present value of the annuity payments equals the value of the initial gift to the trust. This means that the annuity payments are set just high enough that when totaled over the trust’s term, they effectively “zero out” the gift for tax purposes. As a result, there is no taxable gift when the GRAT is established, making it an attractive strategy for wealth transfer without triggering immediate gift taxes.

Here’s a side-by-side comparison table of Zeroed-Out GRATs vs. Regular GRATs:

Feature	Zeroed-Out GRAT	Regular GRAT
Gift tax at creation	None (gift is “zeroed out” using annuity)	Yes (gift = present value of remainder interest)
Use of lifetime exemption	None	Yes, reduces exemption (or triggers gift tax if exemption is exceeded)
IRS hurdle rate impact	Only excess growth above 7520 rate passes tax-free	Same, but more growth may stay in trust due to smaller annuity payments
Annuity payments to grantor	High (to match value of gift)	Lower (less than full value of gift)
Benefit to beneficiaries	Only asset growth above hurdle rate	Both growth and a larger remainder interest from the start
Common strategy use	Frequently used for short-term GRATs with volatile or appreciating assets	Less common; used when large exemption usage is intentional
Estate tax planning flexibility	Limited to simple appreciation transfer	More flexible for structuring dynasty or GST trusts
Risk of failure (if no growth)	Low—grantor just gets assets back	Same, but more downside if gift exemption was used and growth doesn’t materialize
Typical user	Someone looking to minimize gift tax and preserve exemption	Someone looking to use gift exemption before it sunsets or for long-term trusts

 

When GRATs make sense

GRATs aren’t right for everyone. But they may be a good fit if:

• You have a large estate and want to reduce your taxable estate.
• You own assets you expect will appreciate significantly.
• To ensure the GRAT remains effective, it’s important that you are in good health and outlive it.
• You’re willing to accept a modest risk that the GRAT might not produce a tax benefit.

Potential drawbacks to consider

No strategy is without risk or limitations. Here are a few things to keep in mind:

• Mortality risk : If you pass away during the GRAT term, the remaining assets will be returned to your estate and may be taxed.
• No step-up in basis : Assets transferred through a GRAT don’t get a basis step-up at death, which could lead to higher capital gains taxes for heirs.
• Complexity : GRATs must be carefully structured to comply with IRS rules. An experienced estate planning attorney is essential.

How GRATs compare to other strategies

GRATs are just one tool in a broader estate planning toolkit. Here’s how they stack up compared to outright gifts, irrevocable trusts, and Spousal Lifetime Access Trusts (SLATs).

Comparison	GRAT Advantage	Alternative Strategy	Key Difference
GRAT vs. Outright Gifts	Retain income and reduce gift tax exposure	Outright gifts are simpler	Outright gifts may use more of your lifetime gift and estate tax exemption
GRAT vs. Irrevocable Trusts	Focused on shifting appreciation to beneficiaries with retained annuity	Other irrevocable trusts may include tax or asset protection planning	GRATs are often simpler but provide less flexibility for income tax or asset protection planning
GRAT vs. SLATs	Provides annuity income back to the grantor	SLATs provide income to a spouse	Different beneficiary and income direction—grantor vs. spouse

 

Working with an advisor

The rules around GRATs can be intricate. But when used strategically, they can unlock powerful tax savings for families looking to pass on wealth efficiently.

We work closely with estate planning attorneys and tax professionals to help you evaluate whether GRATs—or another vehicle—make sense in your overall plan.