In a so-called grantor retained annuity trust, or “GRAT,” you transfer assets to an irrevocable trust. The best assets to transfer are those that generate substantial income or might show substantial appreciation.  The goal in using a GRAT is to pass on to the next generation the assets you contribute to the trust while paying no or minimal gift or estate taxes.

As the donor of the GRAT, you would retain the right to receive a fixed amount of money from the trust each year, and these distributions to you would continue for a pre-determined number of years. Once the trust payments to you ends the remaining trust assets then pass to family members you have chosen.

Assets you transfer to a GRAT during your lifetime are technically subject to gift taxes, but generally no taxes are actually paid on such transfers.  Tax liability is typically eliminated -- or at least minimized -- because the value of the assets transferred to the GRAT is deeply discounted.  The IRS allows a discount because your children or other family members will have to wait for years to receive the assets from the trust. Therefore, by using a GRAT to take advantage of today’s low interest rates, you can pass large amounts to the next generation with little or no estate or gift taxes.

The one risk in using this type of trust is that if you die before the reserved payments to you have been completed, then all of the GRAT assets will be subject to estate taxes when you die. But, then again, this would have been the case in any event if you had never set up the GRAT to begin with, so there is little to lose by using the GRAT!