If your family’s assets are worth enough to raise concerns about estate taxes (currently $11.7 million for an individual or $23.4 million for a married couple), GRATs (Grantor Retained Annuity Trust) and SLATs (Spousal Lifetime Access Trust) are two types of trusts you can use to protect your assets and provide for your family. However, each has their own requirements and drawbacks, so it is important that high net-worth individuals discuss all their estate planning options with an attorney, accountant, or financial planner before making any decisions. Additionally, the 2021 Congress is currently looking to raise revenue through various means, and one popular suggestion is to lower the estate tax limit (by over ½ in some proposals). Additionally, certain members of Congress have realized that GRATs provide a way to shelter an individual from more drastic tax implications, thus some lawmakers are suggesting doing away with GRATs all together. So how do these planning tools work, and why are they popular for high net-worth clients?
Typically, basic estate planning is designed to direct who receives your assets when you die and how to account for your end of life care. Many clients use trusts to protect minor children from receiving inheritances at a young age or for disabled individuals, or they do not lose government benefits if they receive an inheritance. If you do not have minor children, disabled beneficiaries, or other special reasons for a trust, you may not need a trust if you are below the current threshold for estate taxes.
High-net-worth individuals who do (or may in the future) have a taxable estate, may consider creating an estate plan that minimizes estate taxes. Michigan does not currently impose estate taxes (on the net value of the estate), or inheritance taxes (applied to the portion received by each beneficiary). However, very wealthy Michigan residents still must contend with federal estate tax requirements, which may shift drastically over time (even by the end of 2021) and may be affected by the proposals currently in Congress.
By way of history, the Tax Cut and Jobs Act of 2017 substantially increased the lifetime exemption below which no estate taxes are collected. Until January 1, 2026, individuals can exempt $11.7 million, and couples can exempt $23.4 million (for 2021), adjusted annually for inflation, before federal estate taxes apply. For an estate that is over the estate tax threshold, the inheritance is taxed at a rate of 40%. However, unless Congress extends this deadline, in 2026, those numbers could return to the pre-2018 values of $5.49 million for individuals and $10.98 million for married couples. But more likely, Congress could shorten the deadline to lower the taxable estate limit. If that happens, it could mean that substantially larger portions of high-value estates will be taxed. To combat this, high net-worth individuals may consider using strategies that include various types of trusts to shield assets from the government and reduce the taxable value of their estates, so long as those types of trusts will still be allowed.
A Grantor Retained Annuity Trust (GRAT) is one tool high net-worth individuals can use to transfer their wealth to the next generation, without those beneficiaries paying the high tax rate that would be otherwise payable. It creates an irrevocable trust funded by assets that appreciate or gain value over time (such as an investment portfolio or a business interest). Then, the grantor receives a guaranteed annuity payment out of the trust’s assets for a fixed amount of time (at least two years). If the grantor survives for the entire annuity period, the GRAT transfers the remaining value of the asset tax-free to the trust’s designated beneficiaries. The Grantor (creator of the trust) pays a tax on the assets when the trust is created, but when the annuity expires, the beneficiary receives the assets tax-free.
However, a GRAT’s success depends on:
In addition, once the assets are transferred into the GRAT, that gift is irrevocable. The grantor must either take back the value over the course of the annuity or allow it to pass to the named beneficiaries.
A Spousal Lifetime Access Trust (SLAT) can be another valuable tool as part of a high-net-worth estate plan. It can be useful in protecting generational wealth that passes from one generation to the next. A SLAT creates an irrevocable trust for the benefit of a person’s spouse or other family members, giving the property to the beneficiaries during the lifetime of the grantor, while retaining some indirect access to those assets and their appreciated value for the “health, education, maintenance or support” of the grantor. SLATs are helpful because they are generally not:
However, they are also irrevocable, which means that the grantor cannot change beneficiaries if the spouses later divorce or if children or grandchildren are omitted from the original gift. In addition, the property transferred into a SLAT must:
The SLAT’s trust documents must be written carefully to avoid triggering a step-up basis calculation at the time of the donor’s death. Also, even when each spouse creates a SLAT for the benefit of the other, these trusts must not be reciprocal, or they may cancel each other out for tax purposes.
GRATs and SLATs are two tools at the disposal of high-net-worth individuals during estate planning. However, whether either, or both, should be part of your estate plan will depend on your need for flexibility, the nature of your assets, and who you intend to leave them to.
At NSSSB, we know how important legacy is to high-net-worth families in Michigan. Our Ann Arbor estate planning attorneys can help you identify your top-priority assets and develop strategies and settlement proposals that protect your interest in them. Click here to schedule a consultation with one of our experienced attorneys.