Grantor Retained Annuity Trust (GRAT) — §2702

What is a GRAT?

A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust to which the grantor transfers assets and retains the right to receive a fixed annuity payment for a specified term. At the end of the term, any remaining assets in the trust pass to the beneficiaries (typically children or other family members) gift-tax free. The gift tax value of the transfer to the GRAT is calculated under §2702 as the fair market value of the assets transferred minus the present value of the annuity payments retained by the grantor.

The key advantage of the GRAT is that any appreciation on the transferred assets above the §7520 interest rate (the IRS hurdle rate, 4.6% in April 2026) passes to the beneficiaries gift-tax free. If the assets appreciate at a rate higher than the §7520 rate, the excess appreciation escapes gift and estate tax.

Zeroed-Out GRATs

A zeroed-out GRAT is a GRAT in which the annuity payments are set so that the present value of the annuity payments equals the fair market value of the assets transferred to the trust. This results in a taxable gift of zero (or near zero), so the grantor uses none of their lifetime gift and estate tax exemption. The zeroed-out GRAT is the most common GRAT structure because it eliminates the gift tax risk while still allowing the grantor to transfer appreciation above the §7520 rate to the beneficiaries.

The downside of the zeroed-out GRAT is that if the grantor dies during the GRAT term, the entire GRAT corpus is included in the grantor's taxable estate (§2036). This is the mortality risk of the GRAT.

Rolling GRATs

Rolling GRATs (also called cascading GRATs) are a series of short-term GRATs (typically 2-year terms) that are funded sequentially. The annuity payments received from each GRAT are used to fund the next GRAT. The rolling GRAT strategy reduces the mortality risk of the GRAT (because each term is short) while still allowing the grantor to capture appreciation above the §7520 rate over time.

Rolling GRATs are particularly effective in volatile markets: if the assets appreciate in a given 2-year period, the excess appreciation passes to the beneficiaries; if the assets decline, the GRAT simply returns the assets to the grantor (with no loss of exemption, since the GRAT was zeroed out).

Best Assets for GRATs

The GRAT is most effective for assets that are expected to appreciate significantly above the §7520 rate. The best assets for GRATs include: closely held business interests (especially before a liquidity event), real estate with high appreciation potential, publicly traded stocks with high expected returns, and options or warrants on closely held stock. Assets that are expected to appreciate at or below the §7520 rate are not good candidates for GRATs.

Practitioners should also consider the valuation discount opportunity for closely held business interests transferred to a GRAT. If the business interest qualifies for a minority interest discount or lack of marketability discount, the transfer to the GRAT can be made at a discounted value, increasing the potential for appreciation above the §7520 rate.

GRAT vs. SLAT vs. IDGT

The GRAT, SLAT, and IDGT are all estate freeze techniques, but they have different characteristics and are appropriate for different situations. The GRAT is best for clients who want to transfer appreciation without using their lifetime exemption (zeroed-out GRAT). The SLAT is best for married couples who want to transfer assets to an irrevocable trust while retaining indirect access through the beneficiary spouse. The IDGT is best for clients who want to freeze the value of a closely held business interest and transfer future appreciation to the next generation through an installment sale.

Frequently Asked Questions