Both a Grantor Retained Annuity Trust (GRAT) and a Grantor Retained Unitrust (GRUT) are irrevocable trusts which may be used to transfer rapidly appreciating assets to children or other heirs while retaining most or all of the income produced by the assets. 

With a GRAT, the grantor (the person creating the trust) retains the right to an annuity, which is a fixed dollar amount each year during the term of the trust.  The annuity amount will not vary regardless of the value of the trust.  This assures a consistent annual payment, but there is no protection against inflation.

With a GRUT, the grantor retains the right to the payment of a fixed percentage of the value of the trust each year during the term of the trust.  The amount of the annual payment to the grantor will depend upon the value of the trust.  If the value of the trust rises in pace with inflation, then the value of the annual payments will not be eroded.  But, if the value of the trust does not keep up with inflation, or even goes down, then the amount of the payment to the grantor may also go down.  Thus, the GRUT has both greater upside and downside potential than the GRAT.

All income and appreciation of the trust assets in excess of what is required to make the annual payments to the grantor will accumulate for the ultimate benefit of the remainder beneficiaries (the persons who receive what is left in the trust at the end of the trust term).  If this growth exceeds the annual distributions, the amount transferred to the remainder beneficiaries can exceed the amount originally contributed to the trust.

The trust may have a term of a certain number of years, or may continue for the lifetime of the grantor.  The present value of the grantor’s retained interest is calculated using a discount rate based upon 120% of the Applicable Federal Midterm Rate in effect in the month the trust is funded.   That value is then subtracted from the value of the assets transferred to the trust to determine the value of the gift the grantor is making to the remainder beneficiaries.

Example: a grantor, age 60, transfers $1 million to a GRAT, retaining the right to an annual payment of $50,000 for life.  If the applicable discount rate is 4.2%, the present value of the grantor’s retained life interest would be $642,075, and the value of the gift to the remainder beneficiaries would be $357,925.  If the trust assets grow at an annual rate of 10% and the grantor lives his normal 20-year life expectancy, the grantor would have received payments totaling $1 million (20 years times $50,000) and upon the grantor’s death the trust would have a value of $3,863,750.  Thus, the grantor would have used $357,925 of his lifetime Gift Tax exclusion to transfer what ultimately amounts to $3,863,750 to his remainder beneficiaries.  If instead the grantor created a GRUT retaining a 5% payout for his lifetime, the annual payments would have grown each year so the total of the payments over 20 years would be $1,653,298, and the value for the remainder beneficiaries would be $1,628,895.  With a GRUT, the present value of the grantor’s interest would be $596,220, leaving a gift of $403,780.