For families who have built substantial wealth, estate planning is not just about who is going to receive an inheritance; it’s also about determining how much of that wealth may be lost to taxes and how to pass along future growth in a thoughtful way that minimizes or eliminates tax burdens. One tool worth discussing with an estate planning attorney is a “Grantor Retained Annuity Trust”, commonly called a “GRAT”.
What Is a GRAT?
A GRAT is an irrevocable trust that allows people to transfer assets out of their estates while retaining the right to receive payments from the trust for a set number of years. When that period ends, anything left in the trust passes to the beneficiaries, often children/grandchildren or trusts established for them.
The benefit of this structure is that the grantor may be able to pass along investment growth with little or no taxable gift at the time the GRAT is established. The grantor receives a scheduled stream of payments, and the family receives any value remaining after those payments have been made.
How Does It Work?
First, the grantor places assets into a GRAT. These might be marketable securities, an interest in a privately held company, or another asset expected to appreciate. Next, the trust agrees to make annual payments to the grantor for a specified term, perhaps two, five, or ten years. The amount of each payment is established under federal tax rules when the trust is created.
The Internal Revenue Service uses an interest-rate assumption, called the “Section 7520 rate”, to value the grantor’s retained annuity and the beneficiaries’ future interest. If the GRAT assets earn more than the assumed rate, that excess growth can potentially pass to the beneficiaries at the end of the term.
An Example Using a $2 Million Investment
A parent places $2 million of stock into a five-year GRAT. Assume that the applicable valuation rate is 5% and the stock earns 10% annually. The trust is designed so that the present value of the payments going back to the parent is approximately equal to the value contributed. This is often called a “zeroed-out” GRAT.
Using simplified annual payments of approximately $462,000, the parent would receive about $2.31 million over five years. If the assumed investment returns occur, roughly $416,000 could remain for the children when the GRAT ends, and that $416,000 would not be considered part of the parent’s gross estate (for federal tax purposes.) The actual result depends on the applicable IRS rate, payment dates, asset performance, valuation, expenses, and trust provisions.
The important feature is not the particular dollar amount. It is the opportunity to shift appreciation above the IRS assumed rate to the next generation without using a substantial portion of the grantor’s lifetime gift tax exemption.
Why Might Wealthy Families Consider a GRAT?
A GRAT can be especially appealing when an individual owns an asset expected to increase significantly in value. A business owner who expects a liquidity event or an investor holding concentrated stock with strong growth potential, for example, may want future appreciation to benefit children rather than increase their own taxable estates.
GRATs can also be useful when a family wishes to preserve federal gift and estate tax exemption for other transfers. Properly structured, a GRAT can have a very small taxable gift value at inception, although preparation, valuation, and administration require careful oversight.
What Are the Risks?
A GRAT does not guarantee a tax benefit. If the assets perform poorly, the trust may have little or nothing left after making the required payments. The family then receives no meaningful remainder, although the grantor has received the annuity payments.
There is also a mortality risk. If the grantor dies during the GRAT term, some or all of the trust property may be included in the grantor’s estate for federal estate tax purposes. Shorter GRAT terms can reduce this exposure, but they do not eliminate it.
Another consideration is income tax basis. Property transferred successfully through a GRAT generally carries over its existing income tax basis, meaning it ordinarily does not receive the same stepped-up basis adjustment that might apply to property included in a decedent’s estate. Families should compare potential estate tax savings with possible future capital gains taxes if they are selling those assets in the future.
Finally, a GRAT is irrevocable and must be administered as written. The annuity payments, recordkeeping, valuations, and tax reporting cannot be treated as optional formalities.
Does the Grantor Still Pay Income Tax?
GRATs are commonly designed as grantor trusts for federal income tax purposes. That means the grantor generally reports the trust’s taxable income on the grantor’s own return during the applicable grantor trust period. Paying that income tax personally can allow the trust’s assets to remain invested, potentially improving the amount ultimately available to beneficiaries. Individual circumstances can affect this result.
Is a GRAT Right for Every Wealthy Family?
No. A GRAT is generally most relevant for individuals whose estates may be subject to federal estate tax, particularly when they own assets with strong appreciation potential. It is less attractive when the assets are unlikely to outperform the IRS valuation rate, the grantor’s life expectancy makes the proposed term impractical, or the family needs a simpler and more flexible arrangement. In 2026 the federal tax exemption is $15,000,000 per person and $30,000,000 per married couple, but this number will change in the future, and it could adjust downward significantly when the next administration in the White House pushes through a change to the tax code. There is no way for anyone to know what that new exemption amount will be or if any new laws will change how GRATs work.
Tennessee does not currently have a separate state estate tax, but federal estate tax exposure can still be important for Tennessee families with significant wealth. A GRAT is an estate and gift tax strategy, not a general-purpose Medicaid or TennCare asset protection tool.
For the right family, a GRAT can be an effective way to pass future growth to children or other beneficiaries while limiting the federal gift tax cost of the transfer. Its value depends on careful asset selection, appropriate timing, sound drafting, and disciplined administration.
Before transferring investments or business interests into a GRAT, consult an estate planning attorney and tax adviser who can model the expected results, evaluate the relevant tax rules, and determine how the strategy fits into the family’s overall estate plan.
Legal References
Internal Revenue Code § 2702; Treasury Regulation § 25.2702-3; Internal Revenue Code § 7520; and Treasury Regulation § 20.2036-1.
DISCLAIMER: This article is for general educational purposes only and is not legal or tax advice. Federal tax law and exemption amounts may change, and outcomes depend on the facts of each estate.