Have Too Much Money? ConGRATs

financeHere’s a little article for those of you with too much money. What’s my definition of too much money? Well, lets say you’re in retirement and have investment assets that will put you way over the top of the estate tax.

Lets say you want to minimize your estate tax but also want to maximize the amount of money you leave to your heirs. No matter what you do (short of putting your money in a couple of steel lined briefcases) you’re going to earn interest on your money, why not make the most of it and give it to your kids now?

Luckily for you, the IRS gives you just such a way to pass a fortune to your kids tax free! Its called a GRAT – Grantor Retained Annuity Trust. Well what does that mean and what does it do?

Here’s how it works, I’ll try to keep it simple.

You put money into this irrevocable trust (meaning you can’t take it back until its done) and select a form of annuity payments over a certain period of years (usually 1 or 2 years). The IRS has a set expected annual rate of return, what this means is that they expect your money to earn at least lets say 5% per year. That seems reasonable and easy to achieve. It is and that’s why GRATs are an excellent means of transferring wealth!

Take your money, put it in, and earn whatever you want based on your investments – 10, 11, 12%. So what happens at the end when the trust is done? Well a couple of things:

First, everything you put into the trust plus the 5% the IRS expects you to earn is transferred back to you, its back in your estate. Sorry, you can’t get rid of that so easy slick. However, the 5, 6, or even 7% extra that you earned above and beyond the 5% the IRS stipulated goes to your beneficiaries tax free! Let’s do the math.

The future value of $2,000,000 invested for 2 years with a rate of 12% will be $2,508,800. The future value of $2,000,000 invested for 2 years with a rate of 5% (the IRS assumed rate) will equal $2,205,000. Take the difference and you get $303,800. What does it mean? $303,800 just went to your heirs tax free. $303,800 of interest that you would have otherwise included in your estate is now out of it.

A couple of points to make about GRATs.

  1. If you die before the GRAT ends, it ends up back in your estate.
  2. If you earn less than the IRS rate, GRATs aren’t useful.
  3. You can keep doing one GRAT after another.