Research and Writing for Professionals

Volatility Enhanced GRATs - December 2009

Grantor Retained Annuity Trusts (GRATs) are a particularly good technique to leverage gifts to heirs. With today’s very low interest rates and the government reviewing proposals to lengthen the time period for which GRATS must run, now is a great time to consider using GRATS in year-end planning with clients.

One approach that we have used is a technique we call “Volatility Enhanced GRATs” for a portfolio of investments. This technique is potentially a cost effective way to increase the gifted amount substantially, without increasing gift taxes.

Instead of using one GRAT to hold a portfolio of investments, you should consider expanding to multiple GRATS and fund each with a different, volatile investment which has a low correlation with investments in the other GRATS. This is different from diversifying by time period. Desiring volatility is counter to our traditional investment practices where we try to reduce portfolio volatility. Although somewhat counter intuitive, the client still holds a balanced investment portfolio, but one that is split into different GRATs.

The amount that a client passes to heirs by creating several GRATs under this approach is potentially considerably higher than if a diversified portfolio is placed in a single GRAT. An individual investment is more likely to significantly beat the Section 7520* interest rate than an entire diversified portfolio. Therefore, we can create “Volatility Enhanced GRATs” by placing assets with uncorrelated performance into separate GRATs. Using this technique, the individual investment “winners” have their appreciation passed to the heirs without first having to reduce it by the underperformance of the investment “losers” which, in total, increases the amount gifted versus the traditional approach with a diversified investment. This is strictly the way the math works.

”Volatility Enhanced GRATs” are a heads-the-client-wins if the asset appreciates; tails, the client has no appreciation to pass on and loses little more than gift taxes and legal expenses to create the GRATs. In our opinion, the additional cost of setting up multiple GRATS and administering them can be very worthwhile when the potential upside for clients is considered.

If this is something you would like more information on, please give us a call.

*The Section 7520 interest rate is the rate of return that the property in the trust is assumed to realize during the annuity period and calculated using IRS valuation tables.
Please keep in mind that there is no assurance that this or any strategy will ultimately be successful or profitable nor protect against a loss. Strategies discussed may not be suitable for all investors. Every investor’s situation is unique and their investment goals, risk tolerance and time horizon should be considered before any investment decision. The forgoing is for general information only and is not intended to provide specific advice or recommendations for any individual or entity.

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