Rolling GRATs: A Strategy To Maximize Returns • Learn with Valur

So far we’ve covered the basics of Grantor Retained Annuity Trusts (GRATs) and how to maximize the use of these powerful estate planning tools with Zeroed-Out GRATs. We’ve really only scratched the surface, though; there are several ways to optimize GRATs to pass on even more assets free of estate tax. Probably the most common enhancement is a strategy commonly referred to as rolling GRATs.

But why does this strategy work, and why is it valuable? The key feature is that the trust’s term is much shorter than a traditional GRATs.

What are Rolling GRATs?

A rolling GRAT stands for rolling Grantor Retained Annuity Trust. It is a type of trust that allows you to transfer assets to beneficiaries without incurring gift or estate taxes. With a rolling GRAT strategy, you are setting up a series of short term GRATs as a way to minimize the risk of the GRAT strategy (more on this below) and maximize the assets you pass on to your heirs estate tax free. Rolling GRATS are becoming increasingly popular as a way to avoid paying taxes on large transfers of wealth.

What are the Benefits of Rolling GRATs?

Rolling GRATs are also called short-term GRATs because they present various benefits in comparison to basic GRATs. Some benefits are:

Mortality risk. Most importantly, it is much more likely that you will live until the end of a short-term GRAT. Why does this matter? Because if you pass away during the GRAT trust’s term, the rules state that nothing will pass to your beneficiaries. Instead, all of the remaining assets will instead be included in your estate and subject to the estate tax. This eliminates the benefits of the GRAT entirely. By establishing a shorter-term trust — say, for two years instead of the traditional ten — you reduce that risk.
Volatility. The key arbitrage of a GRAT is that you get to pass on, tax free, any appreciation above the government’s expected growth rate (3% as of May 2022), whereas anything below that “hurdle rate” returns to you. Because, you can take any money that is returned to you and simply try another GRAT, it’s advantageous to target maximum asset growth, even if it means huge volatility. In other words, it’s better (from an estate tax perspective) if your assets have a 50% chance of doubling and a 50% chance of staying flat, rather than a 100% chance of growing, say, 50%. With that fact in mind, shorter trust terms (and, therefore, shorter investment periods) will be better, since the returns will be more volatile. For example, imagine that, over 5 years, a $10 million investment were to return 8%, -3%, 11%, 17%, and 15%. With a single 5-year rolling GRAT, you’d be able to send $1.4 million to your heirs free of estate tax. That’s 124% more dollars passed to your heirs, with one simple change in strategy and no additional effort on your part.‍
Liquidity. While these trusts are operating, you are entitled to a pre-determined distribution each year. While liquidity may not always be an issue, it’s worth noting that rolling GRATs pay out a greater percentage of assets each year, giving you additional flexibility to decide how to use that money. For instance, a 2-year GRAT distributes ~50% of its initial asset value annually, while a 10-year GRAT distributes ~10%. As a result, a series of short- term GRATs will leave you with more assets returning to you annually.

How does the rolling GRAT work in practice?

Rolling GRATs are relatively straightforward. We’ve explained the theory, and now we’ll take a spin through an example to demonstrate how this strategy works in practice. Put simply, you will set up at least one new GRAT per year, each with the same duration — two years is standard. You’d fund the initial GRAT with a portion of your estate, and then you’d take the annual distributions from that trust and fund two additional trusts. Then you’d take the distributions from those trusts to fund additional ones, and so forth. That’ll give you two GRATs operating with the same strategy at the same time, at all times. This process continues on and on until the individual determines they’d like to stop.

A Rolling GRAT Example

Ava is a successful blockchain entrepreneur and published author. She’s married with two children.

Assumptions

Each GRAT will last for 2 years
Expected market rate of return = 10%
IRS discount rate / 7520 rate = 3.0%
Ava’s current net worth = $20 million. In other words, she fully expects to exceed the lifetime gift tax exemption.
Ava is 39 when she sets up her first trust, and she expects to live to 78 (that is, 39 more years).

Funding the initial GRAT

Ava contributes $10 million to the first trust. A the end of the first year, the trust has grown by 10% to $11 million, with a distribution to Ava of $5.22 million. (This is 50% of the amount contributed, plus the IRS’s 3% growth rate.)

This leaves $5.78 million in GRAT 1 after the first year of operation.

Using the first GRAT to fund the second

The moment Ava receives the $5.22 million distribution from the first GRAT at the end of year 1, she funds the second GRAT with those proceeds. This second GRAT will likewise run for two years, with annual payments of $2.73 million. (50% of the initial amount + the 3% growth over two years).

Using the first and second GRAT to fund the third

At the end of year 2: GRAT #1 passes $1.1 million to her beneficiaries and ceases operation, while GRAT #2 holds $3 million.

This is the first year that any money will be transferred to her beneficiaries — $1.1 million, which is what was left in the GRAT #1 after the annual payments, because the assets grew faster than the government’s expected 3% growth rate.

In year 2, Ava had two trusts that were operating independently of each other. At the end of the 2nd year, the first trust will pay her another $5.22 million, and the second trust will pay her $2.73 million, for a total of $7.95 million. Ava will use those cumulative payments to create a newly funded GRAT #3 that holds $7.95 million.

Ava can pursue the same strategy in an ongoing fashion for as long as she wants. At the end of the third year, she’ll pass an additional amount to her beneficiaries — namely, the remainder from the second GRAT — and she’ll fund a fourth trust. Same for the end of the fifth year, and so on. For reference, that could be $3.3 million to her beneficiaries, tax free, over five years, and much, much more over the long term.

rolling grat example — Rolling GRATs example

What are the absolute returns of a lifetime rolling GRAT strategy?

Based on the assumptions above, over a 39 year period Ava would have distributed $49 million to her children completely free of estate tax. If, instead, she had kept the funds in her regular investment account and pursued the same investment strategy, she would have paid at least 40% in federal estate taxes before transferring those funds to her children, leaving them only $29.4 million. The rolling GRAT strategy, in other words, produced an additional $19.6 million, or 66.67% more, for her family! And that’s not even including any potential state related estate/inheritance tax she could avoid!

What happens if I change my mind and want to stop using rolling GRATs?

It’s simple to do so, and even easier with rolling GRATs. To stop using this strategy, all you have to do is stop forming additional GRATs each year. The remaining trusts will complete their terms, and you’ll keep the distributions instead of using them to set up additional GRATs. (Compare this to the traditional 10-year GRAT strategy. In that case, you would have to see the full 10-year term through before changing course, meaning your assets would be locked up for much longer.)

Next Steps

With a rolling GRAT strategy, you’re getting the best of both worlds: You’re maximizing your use of GRATs while drastically reducing the risks associated with traditional long-term GRATs. Put simply, by recycling these funds through multiple GRATs over your lifetime, you can maximize the efficiency of this powerful estate planning structure.

Check out more details with our GRAT calculator, or schedule a time to chat with our team of experts!

About Valur

We built a platform to give everyone access to the tax and wealth building tools of the ultra-rich like Mark Zuckerberg and Phil Knight. 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 it easy and have helped create more than $500m in wealth for our customers.