A grantor retained income trust, or “GRIT,” is an irrevocable trust to which the settlor (i.e., “grantor”) transfers assets while retaining an income interest for a term of years selected by the settlor. Upon expiration of the term, the trust usually terminates and the remaining balance of the assets transferred to the trust, including any undistributed income and appreciation, is distributed to third parties selected by the settlor, usually his or her children, called remainder beneficiaries.

A GRIT is used to reduce gift taxes on the transfer of assets to the next generation. It is best used with highly appreciating assets, including closely-held stock. The value of the gift is determined when the trust is funded, so any appreciation of the assets passes gift tax-free to the remainder beneficiaries. However, the funding of the GRIT is a taxable gift by the settlor to the remainder beneficiaries; the amount of the gift is determined by reference to IRS actuarial tables that fluctuate monthly depending upon the prevailing federal interest rates.

The principal advantages of a GRIT include:

Appreciation of the assets is moved out of the estate and avoids gift tax.
Compared with a direct gift, transfer costs (i.e., gift tax) are greatly reduced, because a taxable gift is made only to the extent that the value of the assets at the time of the transfer exceeds the actuarial value of the retained income interest.
Compared with a direct gift, the settlor maintains control of the assets for a longer period.
The settlor retains some or all of the income from the transferred assets for the term of the GRIT.
So long as the settlor survives the term of the GRIT, the assets used to fund the GRIT are not taxed in the settlor’s estate on his/her subsequent death.

Three cautions apply to a GRIT, however.

  1. First, if the settlor dies during the trust term, all or most of the trust assets would be includable in the settlor’s estate, thus failing to achieve the benefits of the transaction while incurring the transaction costs. The trust term must be carefully selected to provide a great likelihood that the settlor will outlive the term of the trust.
  2. This leads to the second caution, which is that the settlor will (or should) lose the economic benefit of the assets during his or her remaining lifetime.
  3. Furthermore, the transaction will not provide a benefit if the assets do not outperform the IRS discount rate, currently about 5%.

To comply with IRS valuation rules, most GRITs are either grantor retained annuity trusts (“GRATs”) or grantor retained unitrusts (“GRUTs”). A GRAT is a GRIT where the settlor’s retained interest takes the form of an annuity; that is, the settlor retains a fixed right to an annuity payment, to be made at least annually, based on the value of the trust at its inception. With a GRUT, the settlor retains a right to a unitrust payment, to be made at least annually, based on a fixed percentage of the value of the trust property, revalued annually. As a result, when the settlor creates a GRAT, the annuity amount will be ascertainable for the entire term of the trust, while for a GRUT the unitrust payment will vary based on the fluctuating value of the trust assets.

This article is intended to give you enough information to decide which of these estate planning tools might be appropriate, and which are definitely not. We can then discuss further how the ones in which you remain interested may be tailored to meet your goals.