Potential FED Interest Rate Hike Could Hurt GRATs

The grantor retained annuity trust (GRAT) is a common estate planning technique used by wealthy individuals and families seeking to pass down appreciating assets while limiting their estate tax burden.  GRATs work well when interest rates are low, so if the Federal Reserve raises interest rates that could make this type of trust less popular.  This column explains how GRATs need to exceed the IRS set ‘hurdle rate’ in order to get the tax benefits.  A higher interest rate will mean a higher hurdle rate. 

If interest rates are hiked then wealthy clients will likely look to other investment instruments like the qualified personal resident trust (QPRT).  Clients may also consider getting an intrafamily loan as an alternative to a GRAT.  Investing in a GRAT could still be feasible in a period of rising interest rates if the trust holds assets that are rapidly appreciating.  If the returns on an investment are large enough it would not matter if there was a higher hurdle rate. 

See Anna Prior, GRATs Could Lose Allure if Interest Rates Move Higher, The Wall Street Journal, June 14, 2015.

Special thanks to Jim Hillhouse for bringing this article to my attention.