In order to be successful, the GRAT assets will generally need to outperform the Applicable Federal Rate that exists as of the month the assets are transferred to the GRAT. However, since most GRATs are funded with assets subject to a valuation discount, there is a built-in advantage from the beginning since the annuity payment is determined based on a percentage that is applied to the fair market value of the assets transferred to the GRAT. If those assets are discounted to reflect a lack of voting control and that the business is entity is closely-held and has little marketability, the annuity percentage is applied to a lower-valued asset.

The GRAT is successful if the settlor outlives the term-of-years of the trust. If the settlor fails to outlive the term-of-years, then some or all (in most cases, all) of the trust assets are includible in the settlor’s estate. Thus, a GRAT is considered a” bet-to-live” wealth transfer technique. Anyone contemplating the use of a GRAT when preparing for a wealth-shift should consider the probability of outliving the GRAT term. A GRAT is more suited for a younger settlor than an older settlor. A settlor older than 75 or 80 years of age would generally be advised to use a different technique. Life insurance can be used to hedge against the possibility of the settlor predeceasing the term of the GRAT.

One limitation of a GRAT is that the trust cannot skip a generation of your heirs. Thus, there is a transfer tax at the beneficiary’s death. However, if the transferee doesn’t have a taxable estate, then this “disadvantage” is often an advantage, assuming the assets have appreciated in value, because they get a new income tax basis at the transferee’s death.

One advantage of a GRAT that generally doesn’t apply to other wealth-shifting techniques is that there is nearly zero gift tax risk. The reason this is the case is that the trust can use a numerical percentage of the fair market value of the gifted asset in determining the annuity payments. Thus, if the valuation of the gifted asset is doubled on an audit, rather than increasing the value of the gift on a dollar-for-dollar basis, the gift tax value simply doubles. Therefore, if the GRAT is set up as having a gift tax value of $1, then if the IRS audits the valuation of the asset transferred to the GRAT, then the gift tax value is increased from $1 to $2. Many people feel comfortable knowing that no gift tax will be owed. This makes it ideal for those who are risk-averse.

One strategy is to gift a high concentration in a single publicly-traded stock to a short-term two-year GRAT in order to take advantage of the higher volatility of a short-term GRAT as opposed to that of a long-term GRAT. As the annuity payments are made to the settler using stock to make those payments in-kind, the settler will often re-GRAT that stock into new two-year GRATs, a technique called “rolling GRATs.” By continuing to do this, the settlor will often have some successful GRATs in strong two-year periods and some unsuccessful GRATs during weak two-year periods. If just some of the GRATs are successful, the strategy works well.

Another strategy is to structure a high-cash-flow asset, such as equity in a closely held business so that the gift to the GRAT is made using a minority interest, non-voting interest or limited partnership interest. Because of lack of control and lack of marketability discounts, the gift is valued at an amount that is substantially less than pro rata value. The annuity payments are made using the cash flow from the gifted assets. Depending upon the valuation discount and the cash flow, these longer-term GRATs are often approximately six to 12 years in duration.