High-net-worth individuals often seek strategies to transfer wealth efficiently while minimizing gift and estate taxes. Two powerful tools available to you are Grantor Retained Annuity Trusts (GRATs) and Grantor Retained Unitrusts (GRUTs). Both are irrevocable trusts designed to allow a grantor to retain an income stream for a set term while transferring future appreciation to beneficiaries at a reduced tax cost. While similar in concept, they differ in mechanics and ideal use cases.

A Grantor Retained Annuity Trust involves the grantor transferring assets into a trust and retaining the right to receive a fixed annuity payment for a specified term. At the end of the term, any remaining assets pass to the beneficiaries, typically children or other family members.

The IRS values the remainder interest using Section 7520 rates, which are based on 120% of the IRS-produced Applicable Federal Rates. If the assets in the GRAT outperform the assumed rate, the excess appreciation passes to beneficiaries free of additional gift tax. This makes GRATs particularly attractive in low-interest-rate environments or when transferring assets with high growth potential. For example, if the IRS assumes a 4% growth rate and the trust assets grow at 8%, the excess (4%) would pass tax-free to the beneficiaries.

A Grantor Retained Unitrust operates similarly but pays the grantor a fixed percentage of the trust’s value, recalculated annually. This means payments fluctuate based on the trust’s performance. GRUTs are less commonly used than GRATs because the variable payout can erode the remainder interest if the trust underperforms, making them better suited for assets expected to appreciate steadily.

Both GRATs and GRUTs allow the grantor to “freeze” the value of the taxable gift at the time of transfer. Any appreciation beyond the IRS assumed growth rate benefits the heirs without additional gift tax liability. Assets like closely held business interests, pre-IPO stock, or real estate with strong appreciation potential are ideal candidates. GRATs allow these assets to grow outside the grantor’s estate while minimizing upfront tax costs.

Both structures provide the grantor with an income stream during the trust term, which can be appealing for those who want to maintain cash flow while transferring wealth. GRATs are generally preferred for short-term strategies (2–5 years) and assets with predictable growth. They can be “zeroed out,” meaning the actuarial value of the remainder interest is minimal, reducing gift tax exposure. GRUTs, with their variable payouts, are better for grantors who want payments tied to actual performance, but they carry more risk of leaving little remainder for beneficiaries.

There are a few cons to these trusts, though. First off, they are irrevocable, meaning once established, the terms cannot be changed, and once money is placed in the trust, it cannot be removed. Additionally, if the grantor dies during the trust term, the assets revert to the estate, negating the tax benefits. And lastly, if the trust assets do not exceed the IRS 7520 rate, they may be depleted, leaving nothing for the intended beneficiaries. These strategies work best as part of a comprehensive estate plan, often alongside other tools like family limited partnerships or charitable trusts.

In summary, GRATs and GRUTs are excellent tools for efficiently transferring wealth, particularly in environments of low interest rates and high asset growth potential. While GRATs are popular due to their predictability and flexibility, GRUTs can serve specific scenarios where variable income aligns with the grantor’s objectives. Due to their complicated nature, they require careful structuring to comply with IRS rules and avoid unintended tax consequences. It pays to be familiar with them, as the typical clients who find the most value in them tend to be in the high- or ultra-high-net-worth space.

Author: Ryan Naples is a financial planner for The Hucko Group.

Editor: Greg Filbeck, CFA, FRM, CAIA, CIPM, PRM, Samuel P. Black III, Professor of Finance & Risk Management, Penn State Erie, mgf11@psu.edu.