If you have assets that will likely appreciate in value, including property that provides income or stocks that demonstrate growth potential, there are ways you can plan accordingly to help you avoid severe tax consequences that might otherwise be related to retaining these assets or allowing them to become part of your general estate.
Two potential vehicles for you to explore are grantor retained annuity trusts (GRATs) and grantor retained unitrusts (GRUTs). With both of these options, you retain an interest in the income from assets placed in the trust. While there are taxes associated with each of these, they may be less costly than other options depending on your individual circumstances.
The Basics
For either of these trusts, you will transfer income-producing assets into the trust and receive payment from the trust. The biggest difference between the two of these options is how income is distributed to you during the life of the trust. Once established, a GRAT allows you to receive a fixed income amount each year from the trust. This fixed income is established as a percentage of the value of the assets placed into the trust at the time they are placed there.
The minimum yearly income percentage is five percent. For instance, if you place $100,000 worth of assets into a 10-year GRAT, you will need to receive at least $5,000 a year in payouts. Even if the assets within the trust do not generate income within a certain year, the trustee must still pay out the established payment percentage every year for the life of the trust.
With a GRUT, you must also elect a minimum five percent yearly payout for the life of the trust. However, with a GRUT the value of the assets are established each year during the life of the trust, so the payment you will receive will fluctuate based on the appreciation or depreciation of the assets within the GRUT. GRATs may work better for individuals that want to receive a fixed payment each year to help supplement retirement income or for other purposes as they allow you to plan ahead for the exact amount you will receive each year, and they may be beneficial for assets likely to increase in value more quickly. A GRUT may work better for those less dependent on a specified payout each year that simply want to take advantage of the trust’s benefits.
Tax Consequences
As with all aspects of comprehensive estate planning, taxes are a serious consideration. Whichever option you choose, you can transfer income-producing assets to your children or other potential heirs while avoiding certain tax consequences, taking advantage of lifetime gift tax exemptions, and still receiving income from the assets. In either case, the IRS has established how taxes are to be determined. However, the major tax disadvantage of both GRATs and GRUTs is that if you die before the trust ends then the assets will be included in your estate for the purposes of calculating estate tax liability. It is difficult to give a uniform explanation of the taxes that could be related to these trust options because they depend a great deal on a person’s individual circumstances as well as that person’s other tax liabilities.