Spurred by low interest rates and a White House proposal that would reduce the benefits of a popular estate-planning vehicle, financial advisers are encouraging wealthy clients to take advantage of that vehicle before it's too late.
Spurred by low interest rates and a White House proposal that would reduce the benefits of a popular estate-planning vehicle, financial advisers are encouraging wealthy clients to take advantage of that vehicle before it's too late.
The fiscal-2010 budget sent by the Treasury Department to Congress includes a proposal that would require grantor-retained annuity trusts to be in force for at least 10 years before offering tax advantages.
Currently, most GRATs are created with a two- to three-year term.
Since the benefactor must be alive during the term of the GRAT in order to realize the tax advantages, the higher minimum term would make GRATs — which are used to pass assets to heirs free of gift and estate tax — less valuable for many wealthy clients.
“I'm not sure that people will be using GRATs in the future if they shift to a 10-year term,” said William Knox, a principal of RegentAtlantic Capital LLC, which manages $1.7 billion.
"FAIR SHARE'
The proposal to require 10-year terms is “part of the administration's effort to reform tax law so that everyone pays their fair share,” said Treasury spokeswoman Nayyera Haq.
The possibility of the rule change is prompting many advisers to urge their wealthy clients to consider GRATs.
Tom Bentley, senior manager of wealth advisory services for Truepoint Capital LLC, which manages $700 million, recently set up two GRATs — each with $4 million in assets.
“We wanted to hedge against the possibility of the new law going into effect where the minimum term would be 10 years,” he said.
Low Treasury rates are also contributing the surge in the popularity of GRATs. That's because GRATs only work when the assets they hold grow at a faster pace than the IRS-set interest rate used to create the trust, also known as the “hurdle rate.”
Earnings above the hurdle rate are passed to beneficiaries with little or no gift tax.
This month, the hurdle rate stands at 3.2%, down from 5.2% two years ago.
While GRATs are typically established with two- to three-year terms, the low hurdle rate, combined with the threat of a longer minimum term, is also prompting many advisers to create GRATs with terms longer than two years, but less than the proposed 10 years.
FIVE-YEAR TERMS
Mr. Knox, for example, now prefers GRATs with five-year terms.
“If you set one up now using 3.2% and it expires in October 2011, at that point you will have to set them up for 10 years,” if the administration proposal is enacted, he said.
Since the estate of the late Wal-Mart founder Sam Walton won a U.S. Tax Court ruling in 2000 that favored GRATs, use of the vehicle has evolved to the point where they are virtually fail-safe for wealthy benefactors, according to a Treasury Department official who requested anonymity.
Setting up the trusts for relatively short two-year periods allows benefactors to pinpoint asset appreciation, such as selling a closely held company, the official said. “You're not subjecting the investment that went into the trust to market forces over a reasonable period of time, which is what was contemplated when GRATs were created,” the official said.
Indeed, some advisers acknowledge that GRATs have been manipulated in ways not originally intended by the Internal Revenue Service.
“Wall Street has engineered the use of GRATs to the point where it's a guaranteed win,” said Martin Shenkman, member of estate-planning law firm Martin M. Shenkman PC.
E-mail Sara Hansard at shansard@investmentnews.com.
