Wealth Strategy Report
“Shelf” GRATs
OVERVIEW
A Grantor Retained Annuity Trust (GRAT) is a common estate planning technique. In recent years, legislation
has been proposed (but not passed) that would place restrictions on the use of GRATs. This summary gives
an overview of a technique that we call a “shelf” GRAT1. A shelf GRAT is designed to lock in current
historically low interest rates; it can also address restrictions contained in recently proposed legislation.
the GRAT. For this reason, a shorter-term GRAT is
often preferred to a longer-term GRAT;
INTRODUCTION
This1summary assumes you are familiar with GRATs as
an estate planning technique. We have a separate
Wealth Strategy Report discussing the basics of GRATs:
Grantor Retained Annuity Trusts (GRATs). As explained
there in more depth, key features of a GRAT include the
following:

There is a “hurdle rate” that the investments generally
must outperform in order for the GRAT to succeed as
a wealth transfer technique. The lower the hurdle
rate, the more likely
the
GRAT
will
succeed;

It is common for a
GRAT to be “zero-ed
out,” which means the
value of the retained
annuity is equal to the
value of the assets
contributed, resulting
in a taxable gift of $02;

A GRAT
succeed
transfer
only if
outlives
will generally
as a wealth
technique
the grantor
the term of
1
The term “shelf” GRAT comes from the metaphor of putting the
GRAT “on the shelf” during the first few years, until it is “taken
down” and the assets exchanged as described herein.

Often, a series of shorter-term GRATs are preferred
to a single longer-term GRAT because of the reduced
risk of investment underperformance.
THESE FEATURES MAY NOT BE AVAILABLE IN THE
FUTURE
Historically Low Hurdle Rate
As mentioned, a GRAT will generally succeed as a wealth
transfer
technique
only if the total return
exceeds the hurdle
rate. This rate is also
known
as
the
“Section 7520 Rate”
(named
for
the
section of the tax law
that established it).
The IRS releases this
rate each month, and
it is the rate that
governs calculations
for several gift and
estate
planning
techniques for that
month,
including
GRATs.
Some estate planning techniques benefit from a higher
Section 7520 rate; others benefit from a lower rate. In the
case of a GRAT, a lower rate is better. As the chart
shows, since the Section 7520 rate was first implemented
in 1989, it is currently at historically low levels.
2
Usually the gift is not literally $0 but rather is controlled to be a
minimal amount.
1 | Zero-ed out GRATs
The zero-ed out GRAT technique potentially allows you to
transfer wealth without using any of your lifetime
exemption. This technique can be especially attractive
for those who have used all (or for those who do not wish
to use any) of their exemption.
A zero-ed out GRAT can also be viewed as a risk-free
way to make a gift because if the gifted asset
subsequently depreciates, you will not have used any of
your gift tax exemption because the initial gift was $0 (or
minimal). Rather, the worst that will happen is that all of
the GRAT's assets might be paid back to you as part of
the annuity payments.
Recent legislative proposals have included a provision
that would prohibit a GRAT from being zero-ed out,
although these proposals have not indicated how much of
a GRAT must constitute a gift. It could be, for example,
that a GRAT would be required to have a gift at least
equal to a certain percentage of the total value
contributed.
Short term GRATs
Currently there is no required term of a GRAT3. A shorter
term is often preferred for a couple of reasons.
First, in general a GRAT will succeed as a wealth transfer
technique only if the grantor outlives the term of the
GRAT. If the grantor dies during the term, the estate tax
result is generally the same as if the GRAT had not been
created. Therefore, to limit this mortality risk, a shorter
term is often preferred.
Second, in general a GRAT will succeed as a wealth
transfer technique only if, over the term, the assets
outperform the hurdle rate discussed above. A very poor
investment performance during the term of the GRAT can
cause the entire GRAT to fail. The longer the term of a
GRAT, the more chance there could be a period of poor
investment performance that could cause the entire
GRAT to fail as a wealth transfer technique. Therefore,
for a given term of years, it is often preferred to do a
series of recurring shorter-term GRATs rather than one
longer-term GRAT. Although the total term is the same,
the series of shorter-term GRATs would allow a
significant underperformance to affect only one of the
series, whereas a significant underperformance in a
single longer-term GRAT would affect the entire GRAT.
In recent years, legislative proposals have included a
provision that would require that GRATs have a minimum
term of ten years. Such a provision is viewed as a
revenue raiser, and therefore it is often included in
legislation to offset costs. None of these proposals have
been enacted, but it is reasonable to assume this
provision could continue to be a part of future legislative
proposals.
HOW A ‘SHELF’ GRAT COULD PRESERVE THESE
FEATURES
What is a ‘Shelf’ GRAT
A “shelf” GRAT is a GRAT that is created with a term
intentionally longer than is ultimately intended. For
example, if a 3-year GRAT were desired, a “shelf” GRAT
might have a 5-year term. The plan for the first two years
would be to fund the GRAT with an asset such as a bond
portfolio that would be expected to meet, but not
necessarily exceed, the hurdle rate.
After two years,
assuming the total investment return has done no more
than equal the hurdle rate, at that time it would be a 3year GRAT. At that point, assets could be swapped and
it would operate like a “regular” GRAT.4
Shelf GRAT to Preserve Low Rate
A shelf GRAT could be used to preserve the currently low
hurdle rates, which could be a goal regardless of the
other features addressed by recently proposed
legislation. The only “deadline” would be to implement a
shelf GRAT before the hurdle rate increases significantly.
Here is an example. Assume the goal is to have a 3-year
$1,000,000 zero-ed out GRAT at the current low hurdle
rate. Perhaps you have a current GRAT, but you would
like to know it would be possible to do another one in a
few years with the same current low rate.
A 3-year zero-ed out $1,000,000 GRAT with the current
hurdle rate of 1.4%5 would require three annual payments
4
3
Many practitioners believe there is a minimum term of one or
two years.
If a grantor and a wholly grantor trust exchange assets of
equal value, under IRS rulings that does not trigger gain; basis
would carry over.
5
The 7520 rate for April 2012.
2 | of $342,710. If the assets earned a return equal to that
1.4% hurdle rate6, that would produce the following:
Year
Start
1
2
3
$1,000,000
$671,290
$337,978
1.4%
Growth
$14,000
$9,398
$4,732
Annuity
Balance
($342,710)
($342,710)
($342,710)
$671,290
$337,978
$0
One way to preserve your ability to do this in two years at
the currently low rate of 1.4% would be to fund a 5-year
shelf GRAT now with $1,643,867, which would produce
the following:
Year
Start
1
2
3
4
5
$1,643,867
$1,324,172
$1,000,000
$671,290
$337,978
1.4%
Growth
$23,014
$18,538
$14,000
$9,398
$4,732
Annuity
Balance
($342,710)
($342,710)
($342,710)
($342,710)
($342,710)
$1,324,172
$1,000,000
$671,290
$337,978
$0
Note that if the assets in the GRAT produce a total return
of 1.4% for the first two years, then at the beginning of
Year 3 there is a 3-year $1,000,000 GRAT with a hurdle
rate thereafter of 1.4%, which can be “funded” at that time
by swapping assets.
You would not want the value of the 5-year shelf GRAT to
fluctuate too much between initial funding and swapping.
One way to address that could be by coordinating bond
maturities. Using the same example as above, consider
having the 5-year GRAT funded with bonds with the
following amounts and maturities:
Bond Amount Maturity
$342,710
1 Year
$342,710
2 Years
$1,000,000
3 Years
This would provide funding for the annuity payment in
Year 1 and Year 2, and there would be $1,000,000
maturing in Year 3. In Year 3 a swap could be made, in
effect creating a 3-year zero-ed out GRAT with a hurdle
rate of 1.4%.
6
The return of 1.4%, equal to the hurdle rate, is assumed as a
convenience; it illustrates just why this is called a “zero-ed out”
GRAT -- if the assets earn a total return that is equal to the
hurdle rate, there will be zero dollars in the GRAT at
termination.
Shelf GRAT to Preserve Ability to Zero-Out a GRAT
Locking in low interest rates is not the only benefit of a
shelf GRAT. A shelf GRAT can also be used to preserve
the ability to zero-out a GRAT. In this case, the
“deadline” would be to create a shelf GRAT before
legislation is enacted that would restrict the ability to zeroout a GRAT.
The last example, which illustrated how to preserve the
currently low hurdle rate, also illustrates how a shelf
GRAT could preserve the ability to zero-out a GRAT. In
the example, we assumed a 5-year shelf GRAT was
funded with $1,643,867, and it was zero-ed out. If the
assets in the GRAT produce a total return of 1.4% for the
first two years, then at the beginning of Year 3 there
would be $1,000,000 of assets remaining, and there
would be three annuity payments remaining of $342,710
each. If $1,000,000 of assets were transferred to the
GRAT in exchange for the GRAT’s bonds, from that point
on it would operate as a 3-year zero-ed out $1,000,000
GRAT.
Shelf GRAT to Address 10-year Minimum Term
A shelf GRAT could be used to address future legislation
that might impose a 10-year minimum term. You might
prefer a shorter term, either because of the reduced
mortality risk or because of the reduced risk of investment
underperformance, both discussed above. Unlike the two
previous uses of a shelf GRAT (which had a “deadline”
that required action sooner rather than later), in this case
there would be no such unofficial “deadline.” That is, the
following could be done before legislation is passed, but it
could also be done after legislation is passed.
Before legislation is passed. We will continue with the
last example of a 5-year shelf GRAT. If that GRAT were
funded now, and if legislation imposing a 10-year
minimum term were passed in one year (on a prospective
basis), it would still be the case that in Year 3 you could
swap assets into the shelf GRAT. From that point on you
would have, in effect, a 3-year GRAT, in spite of the thenrequired 10-year minimum.
After legislation is passed. If legislation does impose a
10-year minimum term, even then it might be possible to
use a shelf GRAT to address that requirement. We will
vary the example used above.
Assume a 3-year zero-ed out $1,000,000 GRAT funded
with the current hurdle rate of 1.4% would require three
annual payments of $342,710.
Because we are
assuming a 10-year minimum term, however, that would
3 | also be required of a shelf GRAT. You could fund a 10year shelf GRAT with $3,177,343, which would produce
the following:
Year
Start
1
2
3
4
5
6
7
8
9
10
$3,177,343
$2,879,116
$2,576,714
$2,270,078
$1,959,149
$1,643,867
$1,324,172
$1,000,000
$671,290
$337,978
1.4%
Growth
$44,483
$40,308
$36,074
$31,781
$27,428
$23,014
$18,538
$14,000
$9,398
$4,732
Annuity
Balance
($342,710)
($342,710)
($342,710)
($342,710)
($342,710)
($342,710)
($342,710)
($342,710)
($342,710)
($342,710)
$2,879,116
$2,576,714
$2,270,078
$1,959,149
$1,643,867
$1,324,172
$1,000,000
$671,290
$337,978
$0
Note that if the assets in the GRAT are able to produce a
total return of 1.4% for the first seven years, then at the
beginning of Year 8 we have a 3-year $1,000,000 zero-ed
out GRAT, which could be “funded” at that time by having
the grantor contribute assets in exchange for the GRAT’s
assets.
Series of Shelf GRATs
As previously mentioned, for a given term of years, it is
often preferred to do a series of recurring shorter-term
GRATs rather than one longer-term GRAT. Similarly,
shelf GRATs could also be implemented in a series, for
the same reasons.
CONCLUSION
GRATs have been an effective wealth transfer technique,
especially in the low interest rate environment of the past
two years. In light of some recent legislative proposals
and the possibility of increasing interest rates, the benefit
of GRATs could be lessened in the future. A shelf GRAT
may be a way to address the impact of legislative change
and/or interest rate increases. Your U.S. Trust Wealth
Strategist would be happy to discuss this strategy with
you.
— National Wealth Planning Strategies Group
Any examples are hypothetical and are for illustrative purposes only.
Note: This is not a solicitation, or an offer to buy or sell any security or investment product, nor does it consider individual investment objectives or financial situations.
Information in this material is not intended to constitute legal, tax or investment advice. You should consult your legal, tax and financial advisors before making any financial decisions. If
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subsidiaries of Bank of America Corporation. Bank of America, N.A., Member FDIC.
Mar 2012 ARR1D5T2
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