Grantor-Retained Annuity Trust (GRAT) is a form of Grantor-Retained Trust set up by individuals to reduce taxes on an estate. To create a GRAT, a grantor creates an irrevocable trust that is for a limited period of time, paying taxes at the outset of the trust. The grantor receives a non-variable sum as annuity payments based on the fair market value of the trust assets, according to a rate set by the Internal Revenue Service (IRS) regulations (in contrast to GRUTs where payments vary based on the performance of the trust). At the end of the trust’s lifetime, the assets are passed to the beneficiaries without estate or gift taxes.
GRATs have a few unique elements to them. First, the trust must earn interest equal to or higher than the rate set by the IRS. If the interest rate is lower or the grantor dies before the trust ends, the trust will be closed with the assets going to the estate, not the beneficiaries. Second, the trust must be irrevocable in order to receive the tax benefits of a GRAT. Lastly, the grantor may exchange similar investments with the trust to make sure that the trust makes the required amount of interest every year.
[Last updated in January of 2022 by the Wex Definitions Team]