GRAT (Grantor Retained Annuity Trust)

Definition

A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust in which the grantor transfers assets and retains a fixed annuity stream for a defined term. At the end of the term, any remaining appreciation above the IRS-prescribed interest rate (the Section 7520 rate) passes to the remainder beneficiaries — typically the grantor’s children or a trust for their benefit — free of additional gift tax.

A GRAT is one of the most-used estate planning tools for transferring appreciated or high-growth assets out of a taxable estate.

The mechanics

In a “zeroed-out” or Walton GRAT (named after the Walton v. Commissioner Tax Court decision), the annuity is calibrated so the present value of payments back to the grantor equals the value of assets contributed. The result:

1. No taxable gift at funding. The retained annuity is valued equal to the contribution.
2. All appreciation above the 7520 rate passes to heirs. If contributed assets earn more than the 7520 rate (a reasonable expectation over most periods), the excess shifts out of the estate.
3. Grantor trust status. The grantor pays income tax on trust income, further depleting the taxable estate without a gift tax cost.

The 7520 rate is set monthly and is indexed to mid-term Treasury rates. Lower rates make GRATs more powerful — more of the asset’s future growth exceeds the hurdle.

A worked example

Grantor contributes $10 million of pre-IPO stock to a two-year GRAT when the 7520 rate is 4%. The annuity payments over two years return the $10 million plus 4% annual interest. If the stock appreciates to $30 million over two years:

• ~$10.6 million is returned to the grantor (the annuity)
• ~$19.4 million passes to the remainder beneficiaries free of gift tax

The grantor has moved $19.4 million out of their taxable estate without using lifetime exemption or paying gift tax. If the underlying stock had appreciated even more, the transferred amount scales proportionally.

Short-term GRATs and the “rolling GRAT” strategy

Longer GRATs carry mortality risk — if the grantor dies during the term, the assets are pulled back into the estate. To minimize this risk and to compound successes, practitioners often use rolling two-year GRATs:

• Each year, fund a new two-year GRAT with a fresh tranche of assets
• If a GRAT produces large gains (as when funded near a stock low), the excess shifts out
• If a GRAT produces losses, nothing is gifted and no exemption is used — the strategy is heads-you-win, tails-you-tie

Post-liquidity founders, executives with concentrated pre-IPO or post-IPO stock, and operators with volatile private company positions are heavy users of this pattern.

Best candidates for GRAT funding

• Pre-IPO or recently post-IPO company stock with high expected appreciation
• Operating business interests before a sale
• Concentrated public positions (often combined with other concentrated-stock strategies)
• Volatile but fundamentally sound private assets

Limitations and risks

• Mortality risk during the term — asset value returns to the estate if the grantor dies mid-term
• Legislative risk — GRATs have been targeted by proposed legislation (10-year minimum terms, required remainder values, etc.) periodically over the last 15 years
• Administrative complexity — required annuity valuations, payment tracking, and potential in-kind distributions
• Concentration risk for the beneficiary — the remainder trust may end up holding very concentrated positions requiring its own diversification strategy
• Not ideal for assets that will depreciate or that pay low returns — the 7520 rate becomes the hurdle and the strategy becomes economically neutral

GRAT vs IDGT vs SLAT

These three structures are often compared and sometimes layered:

• GRAT — retained annuity, gift-tax-efficient without using exemption, good for volatile high-growth assets
• IDGT — intentionally defective grantor trust, combines gift and sale mechanics, best for larger transfers using lifetime exemption
• SLAT — spousal lifetime access trust, provides indirect access via a spouse while removing assets from the taxable estate

Families with nine or ten figure net worth and strong advisor teams often run all three in parallel.

Related on QP List

• Topics · Estate Planning — broader estate context
• Topics · Post-Liquidity Planning — when GRATs are most valuable
• IDGT, SLAT, Dynasty Trust — related structures

Nothing on this page is legal or tax advice. GRAT mechanics depend on current IRS rules and the applicable Section 7520 rate.