If you’re holding assets that are appreciating fast, pre-IPO stock, a business interest ahead of a sale, real estate in a hot market, a Grantor Retained Annuity Trust is one of the more elegant tools in estate planning for moving that future growth to your kids without touching your gift tax exemption.
Part of our guide: Retirement Planning.
What a GRAT actually does
A GRAT is an irrevocable trust you fund with assets you expect to appreciate, while retaining the right to annual payments back from the trust for a set term, typically 2 to 10 years. Whatever remains in the trust after your final payment passes to your beneficiaries, usually your children, free of gift and estate tax. The IRS calculates the taxable value of that eventual gift based on the present value of what beneficiaries might receive after all your annuity payments. Structure it so that calculated value comes out to zero, and you’ve used none of your lifetime gift tax exemption to move the assets. That’s what people mean by a “zeroed-out” GRAT.
The mechanics: it’s a race against the hurdle rate
The IRS publishes a Section 7520 rate monthly, often called the hurdle rate, and it sets how much the trust has to pay you back each year. If the assets inside the GRAT appreciate faster than that rate, the excess passes to your beneficiaries tax-free. If they don’t, you simply get your assets back through the scheduled payments and you’re out the cost of setting up the trust, nothing more. Say you fund a GRAT with $1 million in pre-IPO stock against a hurdle rate of 3%: the trust owes you roughly $103,000 in year one, a bit more each year after. If that stock appreciates 50% in a year, which isn’t unusual for a successful startup heading toward an IPO, everything above the 3% hurdle flows to your children with no tax consequence.
Why this shows up so often with startup equity
Pre-IPO shares are the textbook use case because they tend to appreciate well beyond whatever the hurdle rate happens to be, and funding the GRAT while the stock is still privately valued, before an IPO pop, locks in a lower starting basis for gift tax purposes. The worst case is you break even: if the company never goes public or the stock underperforms, the assets simply return to you through the annuity payments.
Rolling GRATs instead of one long-term trust
Many advisors favor a series of short, typically two-year, GRATs over a single long-term one. Shorter terms capture appreciation faster, let you start over quickly if one term doesn’t produce excess growth, and keep you flexible as markets shift. Funding a new two-year GRAT annually builds a pipeline of these vehicles rather than betting everything on one long window.
Where GRATs fit, and where they don’t
You’re a good candidate if you hold assets you genuinely expect to outpace the hurdle rate, whether that’s startup equity, real estate in an appreciating market, or a business interest ahead of a liquidity event. You need to be comfortable with an irrevocable structure: once it’s funded, you get the assets back only through the scheduled payments, not on demand. Survivorship matters too. If you die before the GRAT’s term ends, the remaining assets are pulled back into your taxable estate, which makes GRATs a weaker fit for older grantors or anyone with serious health concerns.
The common mistakes are predictable: terms that run too long relative to your life expectancy, growth assumptions based on past performance that has no guarantee of repeating, and underestimating the ongoing administrative load of annual valuations, tax filings, and annuity payments.
What to check before you act
The IRS Section 7520 rate moves monthly and the lifetime gift tax exemption changes with tax law, both of which materially affect whether a GRAT makes sense right now. Neither number should be assumed from an old article; pull the current figures from the IRS or your estate planning attorney before modeling anything. The mechanics described here don’t change, but the numbers that decide whether the strategy is worth the legal fees do, and they’re worth verifying every time you consider funding a new trust.
Educational only, not tax, legal, or investment advice. Check primary sources and speak with a qualified professional before making financial decisions.
