Legal Definitions - grantor-retained annuity trust

A Grantor-Retained Annuity Trust (GRAT) is a type of trust that individuals can set up to reduce taxes on their estate. It is an irrevocable trust that pays the grantor a non-variable sum as annuity payments based on the fair market value of the trust assets, according to a rate set by the Internal Revenue Service (IRS) regulations. The trust is for a limited period of time, and at the end of its lifetime, the assets are passed to the beneficiaries without estate or gift taxes.

For example, let's say John sets up a GRAT and funds it with $1 million worth of stocks. The IRS sets the annuity rate at 5%, so John receives $50,000 per year for the trust's lifetime. After 10 years, the trust ends, and the remaining assets are passed to John's children without any estate or gift taxes.

GRATs have a few unique elements to them. First, the trust must earn interest equal to or higher than the rate set by the IRS. If the interest rate is lower or the grantor dies before the trust ends, the trust will be closed with the assets going to the estate, not the beneficiaries. Second, the trust must be irrevocable in order to receive the tax benefits of a GRAT. Lastly, the grantor may exchange similar investments with the trust to make sure that the trust makes the required amount of interest every year.