| BUSINESSWEEK ONLINE : MARCH 1, 1999 ISSUE | ||||||||
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| PERSONAL BUSINESS
A GRAT Can Be Great for Saving Your Kids a Bundle Worried about estate taxes? With today's low interest rates, estate planners are looking with newfound favor on grantor retained annuity trusts (GRATs) as a way to save your kids a bundle. A GRAT not only shelters valuable assets that you can pass on to your heirs with minimal taxes, but it also lets you receive an annuity for as long as the trust lasts. Any amount the GRAT earns beyond current interest rates when the trust is set up will be estate-tax free. That helps explain why GRATs are popular now, when rates are low. ''With the [high stock] market returns we've seen in the past few years, current rates of 5.6% seem pretty easy to beat,'' says Bob Copland, a partner at Ernst & Young. PALATABLE. You need a few million dollars to make this strategy worthwhile--and a lawyer specializing in estate planning to get it going. With proper planning, assets under $650,000 for a single person, or $1.3 million for a couple, are exempt from taxes. (By 2006, the exemptions will rise to $1 million and $2 million, respectively.) But for those who have run through the exemptions, GRATs offer several advantages. First, there's the payout, which makes giving away the assets--in many cases, stocks--more palatable. And because the Internal Revenue Service assumes that the income stream reduces the future value of the assets, the gift taxes on them are much lower than they would be if the assets remained in your estate or were given outright to your heirs. Say you want to hand down $1 million to your kids. If you're in the top tax bracket and you give it outright, or if it passes to them after your death, it will be taxed at 55%, for a bill of $550,000. Assume instead that you put $1 million in a 15-year GRAT today that grows at 10% a year. You give up all rights to the assets, but retain an annuity of $100,000. (In practice, you could elect instead to take a percentage of the assets annually.) You can act as a trustee and manage the GRAT's assets or appoint a professional to do so. You are liable for taxes on any income or capital gains generated by the trust. But the annuity itself is not taxed. Because the assets are tied up for 15 years and because you retain the annuity, the IRS deems the gift to be currently worth only $57,000 to your offspring, assuming a 5.6% rate of return, says Philip Groves, a tax manager at Arthur Andersen in Chicago. So you'd have to pay the one-time gift tax on only $57,000, or $31,000, when you set up the GRAT. After 15 years, you will have gotten $1.5 million in payouts. But if the assets grow at 10% a year, the original $1 million remains intact. So you pass on $1 million at an estate-tax cost of only $31,000, which you have already paid, vs. $550,000 without a GRAT. What if the trust were set up when rates weren't as favorable, say, 9% instead of 5.6%? That would bulk up the IRS's estimate of the GRAT's worth, prompting a higher gift tax. To keep the gift to $57,000, you would have to boost the annuity--and deplete the trust at a faster rate. After 15 years, only $269,962 would be left, says Groves. Obviously, the more the assets earn, the more that can be transferred free of estate taxes. That's why financial planners advise funding a GRAT with an asset that's likely to appreciate. Trying to start the next Amazon.com? You can put a stake in the GRAT. If the startup goes public and the value of the shares rise, you would have given your kids a great deal of wealth at a nominal tax cost. When setting up a GRAT, remember that the annuity you establish at its outset could drain the trust if the expected growth doesn't materialize. Then you will have paid taxes and legal costs (of up to $20,000 depending on the trust's complexity) and will have left little to your heirs. Equally important, the grantor must outlive the trust. If you die before the GRAT ends, the assets will revert to your estate. As a result, an older person may want shorter terms than a young one. You can hedge that risk by laddering, or setting up several trusts of varying durations, says Ron Kelemen, a Salem (Ore.) financial planner. Or you can purchase insurance to cover estimated estate-tax liabilities. GRATs must be considered in the context of your overall financial goals. Parents who depend solely on GRAT income could be in trouble when the trust ends. But under the right conditions, everyone involved in a GRAT stands to gain. By Pam Black _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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