Maximizing Your Impact: Giving Strategies in Estate Planning

When it comes to estate planning, many individuals seek ways to pass on their assets to loved ones while also maximizing tax benefits and ensuring financial security for themselves and their families. One effective strategy to achieve these goals is by including various giving options within your estate plan. Let’s look at three different planning tools that you might explore: Grantor Retained Annuity Trusts (GRATs), Grantor Retained Unitrusts (GRUTs), and Qualified Personal Residence Trusts (QPRTs).

Grantor Retained Annuity Trust
A Grantor Retained Annuity Trust, or GRAT, is a tool that allows you to transfer assets to a trust while retaining the right to receive an annuity payment for a specific term. At the end of the term, any remaining assets in the trust pass to your chosen beneficiaries. GRATs are particularly useful when you expect your assets to appreciate significantly during the trust term, as any appreciation beyond the annuity rate passes to beneficiaries free of estate and gift taxes.

GRATs offer several benefits:
  • Estate Tax Reduction: By removing the asset’s future appreciation from your estate, you can significantly reduce estate taxes.
  • Potential for Family Benefits: If the assets outperform the IRS-required interest rate, the excess growth benefits your beneficiaries.

Let’s look at what one example of using a GRAT. Bob makes a gift of $1 million gift to a GRAT when the current IRS-required interest rate (§ 7520 rate) is 4.2 percent. The GRAT establishes an annuity to be paid to Bob over five years. If the trust only makes 4.2 percent, Bob will be in roughly the same position as he was when the GRAT was created because everything will be returned to him. If assets of the trust are invested and earn 7.5 percent, then there will be approximately $123,562 remaining that will be transferred to the beneficiaries Bob named, with no gift tax (assuming a zeroed out GRAT). If the trust does even better and makes 10 percent over the course of five years, then his beneficiaries will receive $231,419.

Grantor Retained Unitrust
Similar to GRATs, Grantor Retained Unitrusts (GRUTs) allow you to transfer assets into a trust while retaining an income stream. However, instead of a fixed annuity payment, GRUTs provide a fixed percentage of the trust’s value, which is revalued annually. Since the trust’s value can vary from year to year, the annuity amount can vary even though the same percentage is used each year to calculate the annuity. At the end of the trust term, any remaining assets pass to your chosen beneficiaries.

GRUTs offer some unique advantages:
  • Flexibility and Growth Potential: Since the annuity payout is recalculated annually, the GRUT allows for potential growth. If the trust’s assets perform well and experience growth, the income paid to the grantor can also increase over time, potentially benefiting both the grantor and the beneficiaries.
  • Tax Efficiency: The primary advantage of a GRUT is its potential to reduce estate and gift taxes. By transferring assets into the trust and retaining only a fixed percentage of the trust’s value, the remainder passes to beneficiaries at the end of the trust term, potentially with reduced tax implications.

Qualified Personal Residence Trust
A qualified personal residence trust (QPRT) is an irrevocable trust that you can use to remove the value of your residence from your overall estate. Ownership of the residence is transferred to the trust, and you retain the right to use and enjoy the property for a specified time. Then, once that time terminates, the residence is transferred to your named beneficiary. If you would like to continue living in or using the residence, you will have to pay the beneficiary rent, which may be another strategic method of reducing the size of your estate for estate tax purposes.

Although this transfer reduces your estate for estate tax purposes, gift tax will still be owed when the property is transferred to the QPRT. The value of what is transferred to the trust (the amount subject to gift tax) is the residence’s value less the value of what you keep (because you have the right to continue using it). This estate planning tool’s effectiveness depends on the federal interest rate when the trust is created. The higher the interest rate, the lower the gift value and the lower the potential gift tax liability.

You can establish a QPRT for no more than two residences. It can be funded using a principal residence or a vacation home or secondary residence, or a fractional interest in these types of residences. If the residence currently has a mortgage, it may be advisable to pay off the mortgage before transferring ownership to the QPRT to avoid complications in administering the trust.

QPRTs offer these key features:
  • Estate Tax Reduction: The value of the property is reduced for estate tax purposes, potentially leading to significant tax savings.
  • Residence Retention: You retain the right to live in the property for a predetermined period, providing flexibility and use of the property during your lifetime.

Let Us Help
The important thing to note with all three types of trusts is that you must survive the trust term in order to see the benefits of the strategy. When trying to determine the length of the trust, it is important to consider your current age and life expectancy. If you die before the trust terminates, no tax benefits are realized and the full value of the account or property will be counted towards your estate tax liability. In addition, because each of these transactions is subject to taxation, it is important that you evaluate the gift tax, estate tax, and nontax considerations before making a decision.

We are available to meet with you, discuss your unique situation, and craft a plan that leaves your hard-earned wealth to those you care about as you wish. To learn more, please give us a call.