The Benefits of a Grantor-Retained Income Trust

Several types of trusts can help you manage your assets in a way that supports your estate planning goals while providing potentially significant tax advantages. One of them is a GRIT–grantor retained income trust. Is this an option you should consider? As with all asset management strategies, there are pros and cons depending on your specific situation and estate distribution preferences.

As the name implies, a grantor-retained income trust allows the person who creates it (the grantor) to continue receiving income from the trust’s assets for a specified number of years.

Here’s how it works:

• The grantor decides how many years the trust will be in effect, called the initial term, and who the beneficiary(ies) will be.  
• The grantor transfers assets such as stocks or real estate to create the trust. These assets are removed from the grantor’s estate and considered a gift (to the beneficiaries) based on their total value. However, unlike other types of trusts, GRIT assets are valued at a reduced rate, which is based on a specific formula.
• At the end of the initial term, the assets may be distributed to the beneficiaries. Alternatively, the principal can remain in the trust and beneficiaries can take distribution later on. 

Advantages of a Grantor-Retained Income Trust

Ongoing Income

A GRIT benefits the grantor in that they can retain some level of income. They must take a distribution from the trust at least once a year. That can be an annual lump sum or periodic fixed or variable distributions throughout the year. Distributions can be from interest or a percentage of the assets. This allows the grantor to structure the income to minimize tax ramifications.

Increase Gift Tax Exemptions

Because the value of GRIT assets is discounted when the trust is set up, the amount of gift tax that might be assessed when beneficiaries take distribution may also be lower.

Reduce Estate Taxes

Assets originally transferred into the trust and any appreciated value are not considered part of the grantor’s estate, there are no federal gift or estate taxes.

Flexibility for Beneficiaries

Beneficiaries can receive their distribution right away or wait till later. 

Drawbacks of a Grantor-Retained Income Trust

Close Family Members Cannot be Beneficiaries

This applies to all generations, past, current, and future, and it applies to both the grantor and their spouse as well as their siblings and their spouses. So who can benefit?

• More distant relatives such as nieces and nephews, cousins, etc.
• Personal friends or other non-relatives
• Charities

A GRIT is Irrevocable

Once the trust is established, the grantor cannot change any of the details including terms of the trust or the beneficiaries.

Limited Lifespan

The initial term has a set end date. If the grantor dies before that date, the assets remaining in the trust revert to the grantor’s overall estate where they are once again subject to estate tax. This can eliminate or greatly reduce the expected tax savings.

On the other hand, if the grantor outlives the term of the trust, the assets still pass on to the beneficiaries, leaving the grantor without the ongoing income from those assets.

Risk of Miscalculation

While the grantor has some control over the income stream produced by the trust, there are IRS regulations that govern key details such as minimum interest rate. Payments that are too low may be viewed as a gift instead of a sale, which could result in sizeable tax liability for the grantor.

There is also the possibility that tax laws could change regarding the transfer of assets into a GRIT or the estate tax exemption rate, rendering the trust less valuable as an estate planning tool than expected.

A grantor-retained income trust can serve dual purposes, assuring the grantor access to continued income while allowing them to pass along assets without tax burden. However, there may be more suitable choices. An estate and tax planning expert can help you understand the facts and ramifications of all available options so that you can make the best decision for yourself and your heirs.