By Liz Moyer
A strong stock market is prompting investors to rethink assets
they previously gave away to family members in trusts.
Some individuals who set up grantor retained annuity trusts, or
GRATs, in previous years now are swapping out the investments they
put into those trusts--and replacing them with other holdings, cash
or promissory notes that are of equal value today.
Buying an asset from the trust can lock in tax-sheltered
appreciation for the trust beneficiaries.
"It is a sensible solution for investors who might be concerned
that we are nearing the end of a bull market," says Paulina Mejia,
a managing director and wealth strategist at Atlantic Trust, the
U.S. wealth-management arm of Canadian Imperial Bank of Commerce,
in New York. Her clients frequently use the strategy.
GRATs became popular more than a decade ago among people looking
to transfer wealth from one generation to the next without a big
tax bite. A GRAT has a limited term, typically about two to five
years, and is set up to hold assets that are expected to increase
in value. The creator of the trust often reserves the right to
switch the assets it holds.
While the GRAT is in place, the owner typically gets annual
payments from the trust that ultimately equal the amount he put in
plus interest. (It is set up that way to avoid gift tax.) When the
GRAT ends, assuming the original holdings indeed go up in value,
the assets still in the GRAT pass to a different type of trust for
the recipients.
The strategy effectively transfers the increase in the value of
the trust's initial holdings to a beneficiary without triggering
any gift or capital-gains taxes, which can range up to 40% on the
federal level.
Say a GRAT holds shares of Apple, which have doubled in price
since the beginning of 2012. The creator of the GRAT, worried the
markets might be heading down soon, buys the Apple shares from the
trust with cash at their current market value.
That locks in the gain in value for the trust and puts the stock
back in the investor's estate. If he continues to hold the shares,
they can eventually pass to the heirs after the owner's death free
of capital-gains taxes.
Investors also can swap assets in GRATs for other reasons. For
instance, if investments put in the trust have performed well and
are expected to continue to do so, an investor might want to
reclaim any future appreciation for himself. (This assumes the GRAT
wasn't set up with a limit on the value of the assets that will
pass to beneficiaries, a feature included in some of these
trusts.)
Advisers say this strategy has come up with clients who are
feeling cash-poor and want to swap a promissory note for an asset
in a GRAT that is expected to continue to perform well. As long as
that expectation is met, and the owner can repay the promissory
note plus interest with money left over, the strategy works.
Some clients have done this to "replenish their balance sheets,"
says John Buttita, an estate lawyer at Greenberg Traurig in
Chicago.
The move also appeals to many people who set up trusts hastily
at the end of 2012, when the estate-tax exemption was set to fall
to $1 million from $5.1 million. That triggered a flurry of
tax-shelter creation.
Instead, the exemption was set at an inflation-adjusted $5
million for 2013--leading to a little "planning remorse" these
days, says Mark Parthemer, a senior fiduciary counsel and head of
legacy planning in the Southeast at Bessemer Trust. (The estate-tax
exemption is $5.4 million this year for individuals, and $10.8
million for couples.)
While people can't undo the GRATs they created, they can move
particularly promising assets back into their personal portfolios
to reclaim the future appreciation.
Investors should consult with their advisers about any asset
swap because it could affect both portfolio allocation and estate
planning. Assets in trusts also are protected from creditors, Mr.
Parthemer notes.
Write to Liz Moyer at liz.moyer@wsj.com
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