A Grantor Retained Annuity Trust (GRAT) is an estate planning tool that allows an individual (the grantor) to transfer assets to an irrevocable trust while retaining the right to receive a fixed annuity payment for a specified period. The annuity payment is based on the value of the assets transferred into the trust, and at the end of the trust term, any remaining assets pass to the designated beneficiaries, often family members or heirs.

Here’s how a GRAT typically works:

1. **Grantor creates the trust:** The grantor establishes an irrevocable trust and transfers assets, such as stocks, real estate, or other property, into the trust.

2. **Retained annuity payments:** The grantor retains the right to receive an annual annuity payment from the trust for a fixed number of years. The annuity amount is determined at the outset and can be a fixed dollar amount or a percentage of the initial value of the assets transferred to the trust.

3. **Term of the trust:** The GRAT has a specific term, usually ranging from 2 to 10 years. At the end of this term, any remaining assets in the trust pass to the designated beneficiaries.

4. **IRS interest rate:** The IRS prescribes a minimum interest rate, known as the Section 7520 rate, which is used to calculate the present value of the annuity payments and the remainder interest passing to the beneficiaries. If the assets in the trust appreciate at a rate higher than the IRS interest rate, there will be a transfer of wealth to the beneficiaries with potential estate tax savings.

5. **Gift tax implications:** The grantor makes a taxable gift when funding the GRAT, but the value of the gift is reduced by the present value of the retained annuity interest. This reduction can result in a lower gift tax liability.

6. **Successor beneficiaries:** In the event that the grantor does not survive the term of the GRAT, the remaining assets may be transferred to a successor beneficiary, such as the grantor’s spouse or children.

GRATs can be an effective strategy for transferring wealth to heirs with reduced or eliminated gift and estate taxes. However, the success of a GRAT depends on various factors, including the performance of the assets in the trust and the length of the trust term. It’s essential to consult with financial and legal professionals to determine if a GRAT is appropriate for your specific financial situation and estate planning goals. Keep in mind that tax laws and regulations may change, so staying informed about the current legal landscape is crucial.