Grantor Retained Income Trust

A grantor retained trust in the form of a grantor retained income trust or a grantor retained annuity trust provides an attractive option for estate planners given their ability to provide tax savings and income for the grantor while still providing for beneficiaries in the long term.

Grantor Retained Income Trust (GRIT)

A grantor retained income trust, or GRIT as it is commonly known as, is a type of irrevocable trust set up whereby the grantor transfers assets to the trust while retaining the right to receive income earned from the trust assets for a specified term of years (the “initial term”).

The GRIT's trustee distributes income generated by the trust to the grantor annually or on a different term defined by the trust agreement during the initial term. When the initial term expires, the remaining trust principal is either distributed to beneficiaries or held in further trust for the benefit of beneficiaries at a later date. If the Grantor survives the initial term of the GRIT, all principal is excluded from the Grantor’s estate for federal estate tax purposes.

Financial planners will find that the primary advantage of establishing a GRIT rests in the tax benefits when assets are transferred from the Grantor to the GRIT. These assets are valued for federal gift tax purposes at a discount. The amount of discount will depend upon the length of the initial term of the GRIT, and the effective federal rate the month the GRIT is established. The discount rate is calculated by taking 120% of the average yield over the prior month on mid-term U.S. Treasury securities.

Grantor Retained Annuity Trust (GRAT)
A second type of trust under the classification of grantor retained trusts is the grantor retained annuity trusts (GRAT). This kind of grantor annuity trust is created by transferring assets to an irrevocable trust for the benefit of one or more non-charitable beneficiaries which retains an annuity interest for a set term of years.  
A further consideration involves transfer tax valuation. Under this scenario, the taxable gift amount is the fair market value of the property minus the value of the retained annuity interest held by the grantor.  
When the term reserved for the grantor expires, trust assets are distributed to the beneficiaries. If the grantor dies during the GRAT’s term, the remainder interest’s value is included in the grantor’s taxable estate.
From an estate planning perspective, a GRAT offers significant benefits. The value of a transfer to the GRAT for gift tax purposes is the fair market value of the asset transferred less the value of the grantor's retained annuity interest determined under section 7520 of the Tax Code. If, during the term of the GRAT, assets in the trust outperform the section 7520 assumptions, substantial transfer tax savings can be realized.
An example of savings under a GRAT  can be found in the following illustration.  Assume a 50-year-old grantor transfers $2,000,000 in appreciating assets into a GRAT on December 1, 2000, when the section 7520 rate was 7.2%. The annuity under the GRAT is set at 5% of the initial fair market value of the assets transferred to the trust or ($100,000) paid annually for ten years. After the expiration of this term, the trust assets will be distributed to the grantor's grandchildren. The grantor will need to include the $100,000 on his individual income tax return. The remaining money in the trust is not relevant for income tax purposes further at the end of the term these assets remaining are then distributed, free of transfer tax, to beneficiaries or another trust.

Comparing GRITS and GRATs
The primary differences between the two forms of trust discussed above are in the manner payments to the grantor are calculated and how payments are made. The following issues are determinative as to whether a GRIT or a GRAT should be adopted as an estate management tool.
For example, consider the potential Federal tax liability to which your estate may be subjected. The age and health of the grantor or, in other words, the expected life span of the grantor. Whether leaving the remainder to designated beneficiaries will impose a financial hardship on the grantor. If it is anticipated leaving the remainder to beneficiaries at the expiration of the term of years another estate planning tool may be a better option.
A grantor retained income or annuity trust attorney can provide an evaluation as to whether this structure is an appropriate asset management vehicle. Counsel experienced in trusts can also provide advice regarding the tax implications and financial impact of this form of trust. Given the amount of trust arrangements available discussing these options with counsel experienced in wealth management and asset protection is an important first step in this decision-making process.