Supercharging GRAT Returns With Direct Indexing

Grantor Retained Annuity Trusts, or GRATs, are considered the most powerful tool for helping families reduce or even eliminate estate taxes. The proof is in this stark reality: 99 out of the 100 richest American families are known to use GRATs. And when we say that these families use GRATs, we don’t mean that they’ve casually set up one or two trusts for their kids; in most cases, these families establish hundreds of GRATs over the course of their lifetimes.


Because each GRAT allows families facing the estate tax to pass money to the next generations free of estate tax and without using their lifetime gift exemption (the amount you are allowed to give away free of estate tax during your lifetime or when you pass away). And with Valur’s optimized “Direct-Indexed GRAT,” you can do even better, boosting how much your family is able to pass on by 98%, on average, compared to other GRAT strategies.

Let us explain, starting with the basics.

What Is The Estate Tax?

The estate tax is a tax on the transfer of assets between generations — for example, from parents to their children. It is a tax on the total value of assets gifted during one’s lifetime and then the remainder of their estate when they pass away, minus an exempted amount that varies by jurisdiction. In 2023, individuals can transfer up to $12.92 million, during life or at death, without triggering the federal estate tax, and each state has its own exemption. With that said, the lifetime exemption is scheduled to drop substantially, to about $6.6 million, when the Tax Cuts and Jobs Act sunsets in 2026.

Federal estate taxes alone are 40%. This means that if you have $1 million over and above the estate tax exemption, you would owe $400,000 in federal estate taxes and, therefore, would leave behind only $600,000 for your beneficiaries. And that’s before accounting for any state estate tax liability or other taxes. That’s leaving a lot of money on the table but that’s where GRATs come into play as they can help you avoid estate taxes.

What Is A GRAT?

GRAT is a form of trust — a simple but powerful estate planning structure that allows individuals and families to avoid estate taxes as they pass assets on to the next generation. The mechanics are straightforward: An individual (the “Grantor”) makes an initial contribution to a GRAT and collects annual payments (”annuities”) from the trust, so that they get back their initial contribution plus interest at an IRS-imposed interest rate (known as the “7520 rate”) over the life of the trust. If the individual gets their initial contribution back, what’s the point of GRATs?

At the end, the remaining assets (that is, whatever growth the assets inside the trust achieved above the interest rate) are distributed to the beneficiaries (typically children or other family members) free of estate tax and without using the Grantor’s lifetime gift exemption.

When To Use A GRAT?

Wealthy (and soon-to-be-wealthy) individuals typically use GRATs when they want to pass on more assets than allowed by the lifetime gift exemption to anyone but their spouse. The lifetime gift exemption is the amount you are allowed to give away free of estate tax during your lifetime or when you pass away. It’s currently $12.92 million per person, or $25.84 million for a married couple, but that is set to be cut in half at the end of 2025 unless Congress takes action.

What Is The 7520 Rate?

The 7520 rate is a government interest rate that is published monthly by the IRS. In the context of GRATs, the 7520 rate is the rate used to calculate the annuity payments that the Grantor of the trust receives during the GRAT’s term. The grantor contributes assets to the GRAT and receives annual payments from the trust such that they will have collected their initial contribution plus the 7520 interest rate (in particular, the rate that was in place when they established the trust) over the trust’s term.

The 7520 rate plays a crucial role in determining the success and tax efficiency of a GRAT strategy as all the growth above the 7520 rate passes on estate tax free to future generations. Everything else being equal, the lower the 7520 rate, the better GRATs perform. On the other hand, the higher the 7520 rate, the more impactful Valur’s Direct Index GRAT strategy has relative to a traditional optimized GRAT.

Basic GRAT Examples

As we’ve explained, GRAT mechanics are not complicated. The Grantor sets up the trust, receives the principal back plus interest, and passes any additional asset growth on to beneficiaries free of estate taxes. To make sure you understand how GRAT’s work, we’ll walk through 3 basic GRAT scenarios to show how they work.

GRAT Scenario Walkthrough

  • Scenario 1: You own $100 of one stock — Stock A — and place it in a GRAT. The stock grows from $100 to $200 in the first year and stays at that value through the end of year 2.
  • Scenario 2: You own $100 of one stock — Stock B — and place it in a GRAT. The stock decreases from $100 to $50 in the first year and stays at that value through the end of year 2.
  • Scenario 3: You own $100 of both Stock A and Stock B and place them in a single GRAT. They achieve the same returns as above, combining to go from $200 to $250 in the first year and staying at that value through the end of year 2.

In all three scenarios, the GRATs owes a first year annuity of 54%, based on a 5% 7520 rate, of the starting value (or amount the GRAT is funded with) and 54% of that starting value in the second year as the second year’s annuity. Anything left behind after that will be the remainder left for the beneficiaries estate tax free. Now if the GRAT runs out of money and can’t pay the owed annuity, the GRAT pays out as much as it can and ‘fails’ or ends paying you all of the assets in the GRAT.

Scenario 1:

  • First Year: You start with $100 of Stock A, and that grows to $200 by the end of the first year. Drawing on the 7520 rate, we can calculate that the first-year annuity will be 54% of the starting value of $100, or $54. After the first year annuity is paid, $146 is left in the GRAT.
  • Second Year: You start the year with $146 of Stock A and end the year with the same amount. The GRAT pays out the same $54 annuity in the second year, leaving $92 in the trust. That $92 becomes the remainder value that passes on to your beneficiaries estate tax free.
  • Conclusion: This is an ideal case for a GRAT. All of the trust’s assets go up faster than the 7520 rate, so the remainder is large — 92% of the starting GRAT value.
Scenario 1: Stock A GRAT
Remainder Value$92
Annuity Payments$108
Year 1 Starting Value$100
Year 1 EOY Value$200
Year 1 Annuity Payment$54
Year 2 Starting Value$146
Year 2 Annuity Payment$54

Scenario 2:

  • First Year: You start with $100 of Stock B, and it loses value, falling to $50 in the first year. No matter the growth or decrease in value, though, the annuity is the same: 54% of the starting value of $100, or $54. But here’s why the trust’s performance matters: Because it lost so much value, it does not have enough to cover the first year’s payment, so we say that the GRAT “fails.” What does that mean? In these circumstances, the trust will pay out as much of the annuity as it can — here, $50, which is the total remaining after the first year — and then will be wound down, resulting in no remainder for the beneficiaries.
  • Conclusion: Although the beneficiaries don’t earn a tax-free gift in this scenario, a GRAT failing isn’t as bad as is sounds. All it means is that the assets you put into the trust are returned back to you, effectively bringing you back to the situation you started with. As a result, this GRAT distributes $50 back to the Grantor and leaves $0 for the beneficiaries.
Scenario 2: Stock B
Remainder Value$0
Annuity Payments$50
Year 1 Starting Value$100
Year 1 EOY Value$50
Year 1 Annuity Payment$50
Year 2 Annuity Payment$0 (because nothing is left)

Scenario 3:

  • Recall that in this scenario, you own $100 of both Stock A and B, you place them in a single GRAT, and both stocks achieve the same performance as in the other scenarios.
  • First Year: Collectively, the stocks grow from $200 to $250. The GRAT owes an annuity equal to 54% of the starting value, or $108 (the same as the total annuity that was owed out of both GRATs in scenarios 1 and 2). After the first year, $142 are left in the GRAT ($250 – $108).
  • Second Year: The GRAT starts and ends the year with $142. The GRAT pays out its second annuity of $108, leaving $34 behind. As a result, this GRAT distributes $216 back to the Grantor and leaves only $34 for the beneficiaries free of estate taxes.
  • Conclusion: As you will have noticed, even though scenario 3 is just a combination of scenarios 1 and 2, your GRAT ends up leaving behind a significantly smaller remainder ($34) than those other scenarios combined ($92) and instead returns more to the Grantor ($216 versus $158).
Scenario 3: 1 GRAT for Stock A + B
Remainder Value$34
Annuity Payments$216
Year 1 Starting Value$200
Year 1 EOY Value$250
Year 1 Annuity Payment$108
Year 2 Starting & Ending Value$242
Year 2 Annuity Payment$108

A Key Insight

Why does the combined scenario perform significantly worse? The short answer is that GRATs perform better the greater the volatility and variation in their year-by-year performance. We’ll give you the long answer — and explain how you can take advantage of this insight with Valur’s Direct Indexing GRAT strategy to maximize your returns — in the next installment in this series.

Next Steps

You’ve read up on the basics of a GRAT, and now you know more about how Grantor Retained Annuity Trust rules. If you’re interested in going deeper still, then, access our calculator to evaluate the potential return on investment given your situation, or schedule a meeting with us.

About Valur

We’ve built a platform to give everyone access to the tax and wealth building tools typically reserved for wealthy individuals with a team of accountants and lawyers. We make it simple and seamless for our customers to take advantage of these hard-to-access tax-advantaged structures so you can build your wealth more efficiently at less than half the cost of competitors. From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $1.1 billion in additional wealth for our customers.

If you would like to learn more, please feel free to explore our Learning Center, check out your potential tax savings with our online calculators, or schedule a time to chat with us!