A grantor retained annuity trust can be part of your estate plan if you are exposed to the federal estate tax. In this post we will look at the “zeroed out” grantor retained annuity trust strategy. First, we must provide some background about the federal estate tax parameters.
Exclusion and Maximum Rate
At the end of 2010 a tax relief act was passed that set the estate tax exclusion at $5 million in 2011. This act called for annual adjustments to account for inflation. A couple of years later, the Taxpayer Relief Act of 2012 made this arrangement permanent.
After a series of inflation adjustments the exact amount of the federal estate tax exclusion in 2014 is $5.34 million. This figure could rise next year if another inflation adjustment is applied.
The top rate of the federal estate tax stands at 40 percent.
Federal Gift Tax
There is also a federal gift tax that is unified with the estate tax. Large gifts that you give are subject to taxation. The gift tax and the estate tax are unified. The $5.34 million exclusion is a unified exclusion, and it applies to gifts that you give along with your estate.
Grantor Retained Annuity Trusts
Now that you understand a bit about these transfer taxes, we can look at grantor retained annuity trusts. The idea is to fund the trust with assets that you would expect to appreciate considerably. You name a beneficiary who would assume ownership of any remainder that may be left in the trust after its term expires.
When you are drawing up the trust agreement you must decide on a term, and you take distributions from the trust throughout this term.
The act of funding the trust is potentially an act of taxable gift giving, because the beneficiary may assume ownership of resources that could remain in the trust. The Internal Revenue Service calculates the taxable value of the gift by applying something called the hurdle rate to account for anticipated growth. This is 120 percent of the federal midterm rate.
You want to zero out the grantor retained annuity trust, so you calculate the annuity payments to equal the entire taxable value of the trust. Theoretically, there would be nothing left for the beneficiary to inherit, so there is no gift tax exposure.
In the beginning you endeavored to fund of the trust with highly appreciable assets. If the assets outperform the hurdle rate that was applied by the IRS at the outset, there would in fact be assets remaining in the trust at the conclusion of the term.
The beneficiary that you named in the trust agreement would assume ownership of these resources, and the transfer would take place in a tax-free manner.
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