Overview
For many years, certain trusts have proven exceptionally effective for wealthy individuals and to transfer some of their assets to the next generation that minimizes gift and estate taxes. Two of the most powerful tools in this area are the grantor retained annuity trust (“GRAT”) and the charitable lead annuity trust (“CLAT”). For assets expected to grow in the near future, both are particularly productive during periods of low interest.
Why GRATs and CLATs Matter for Estate and Tax Planning
In general, it is beneficial to transfer assets earlier rather than later when they are undervalued or poised for growth. In doing so, this “freezes” the taxable value of the assets. For the transfer of shares of a privately held business or an actively managed portfolio, GRATs and CLATs can (1) remove growing assets from the grantor’s taxable estate and (2) leverage annuity payments to greatly reduce and perhaps eliminate any gift and estate tax consequences.
What Is a GRAT?
A GRAT is an irrevocable trust with a fixed term initially funded by the grantor with a single contribution. During its lifecycle, the GRAT returns an annuity amount to the grantor, then finally distributes all remaining assets to the grantor’s chosen beneficiaries.
How GRATs Transfer Wealth
The success of a GRAT depends on the transferred assets appreciating at a rate greater than the IRS assumed annual rate of return. For GRATs funded in January 2026, this rate is 4.6 percent. The grantor selects a predetermined annuity amount with the expectation that GRAT assets will grow well in excess of the assumed rate of return. The difference between the actual rate of return on the assets and the IRS assumed rate of return will pass, gift tax-free, to the beneficiaries at the end of the GRAT term.
CLATs: A Charitable Variation of a GRAT
CLATs operate as a “spilt interest” trust, benefitting current and remainder beneficiaries. A CLAT is similar to a GRAT with one important difference: Its annuity payments are given to the grantor’s chosen charitable organization rather than going back to the grantor. At the end of the trust term, the remaining balance is distributed to the grantor’s family or other noncharitable beneficiaries.
As with GRATS, the grantor may assign an annuity amount, which, on paper, would leave practically nothing for the remainder beneficiaries based on the IRS assumed rate of return. In reality, however, assets growing above this assumed rate result in a substantial gift for the beneficiaries with little or no gift tax cost.
Income Tax Benefits of a CLAT
CLATs have potential income tax benefits for the grantor depending on how they are structured.
- When set up as a “grantor trust,” the grantor continues to recognize the taxable income produced by trust assets, but takes an immediate charitable income tax deduction based on the present value of the charitable annuity.
- If an immediate deduction is not needed the year the CLAT is created, it may be structured as a “non-grantor trust.” The trust could benefit from deductible charitable gifts for the annuities it distributes to the charitable organizations.
When GRATs and CLATs Are Most Effective
For clients considering significant lifetime transfers of steadily growing or clearly undervalued assets, GRATs and CLATs remain essential considerations. At this time of relatively low interest rates and the possibility of further rate cuts, these strategies can provide exceptional tax savings. Because these trusts are irrevocable and should be considered as part of a broader estate plan, careful planning and professional guidance are important.
Why GRATs and CLATs Matter for Estate and Tax Planning
In general, it is beneficial to transfer assets earlier rather than later when they are undervalued or poised for growth. In doing so, this “freezes” the taxable value of the assets. For the transfer of shares of a privately held business or an actively managed portfolio, GRATs and CLATs can (1) remove growing assets from the grantor’s taxable estate and (2) leverage annuity payments to greatly reduce and perhaps eliminate any gift and estate tax consequences.
What Is a GRAT?
A GRAT is an irrevocable trust with a fixed term initially funded by the grantor with a single contribution. During its lifecycle, the GRAT returns an annuity amount to the grantor, then finally distributes all remaining assets to the grantor’s chosen beneficiaries.
How GRATs Transfer Wealth
The success of a GRAT depends on the transferred assets appreciating at a rate greater than the IRS assumed annual rate of return. For GRATs funded in January 2026, this rate is 4.6 percent. The grantor selects a predetermined annuity amount with the expectation that GRAT assets will grow well in excess of the assumed rate of return. The difference between the actual rate of return on the assets and the IRS assumed rate of return will pass, gift tax-free, to the beneficiaries at the end of the GRAT term.
CLATs: A Charitable Variation of a GRAT
CLATs operate as a “spilt interest” trust, benefitting current and remainder beneficiaries. A CLAT is similar to a GRAT with one important difference: Its annuity payments are given to the grantor’s chosen charitable organization rather than going back to the grantor. At the end of the trust term, the remaining balance is distributed to the grantor’s family or other noncharitable beneficiaries.
As with GRATS, the grantor may assign an annuity amount, which, on paper, would leave practically nothing for the remainder beneficiaries based on the IRS assumed rate of return. In reality, however, assets growing above this assumed rate result in a substantial gift for the beneficiaries with little or no gift tax cost.
Income Tax Benefits of a CLAT
CLATs have potential income tax benefits for the grantor depending on how they are structured.
- When set up as a “grantor trust,” the grantor continues to recognize the taxable income produced by trust assets, but takes an immediate charitable income tax deduction based on the present value of the charitable annuity.
- If an immediate deduction is not needed the year the CLAT is created, it may be structured as a “non-grantor trust.” The trust could benefit from deductible charitable gifts for the annuities it distributes to the charitable organizations.
When GRATs and CLATs Are Most Effective
For clients considering significant lifetime transfers of steadily growing or clearly undervalued assets, GRATs and CLATs remain essential considerations. At this time of relatively low interest rates and the possibility of further rate cuts, these strategies can provide exceptional tax savings. Because these trusts are irrevocable and should be considered as part of a broader estate plan, careful planning and professional guidance are important.
