If you have attended a Brown Brothers Harriman (BBH) investor day or one of our regular markets and economy webinars, you may have heard Chief Investment Officer Scott Clemons say that “volatility is our friend.” During periods of volatility, particularly downside volatility, it often does not feel that way. In turbulent markets, we are patient investors, we work with clients to reconfirm their investment goals, we take advantage of price dislocations in the market, and we go back to fundamentals with our clients in discussing what this wealth is for and when, how, and for what reasons the family plans to access it.

While we frequently address the impact of price volatility in our investment portfolios, it also makes sense to consider estate planning and wealth transfer opportunities that generally present themselves for limited windows when there is volatility in interest rates, public, and even private markets. These strategies include:

• Grantor Retained Annuity Trusts (GRATs): Low hurdle rates make it more likely that a GRAT will succeed in transferring wealth tax-free. Higher hurdle rates (as we are experiencing today) do not mean abandoning GRAT strategies, but the asset selection becomes critical, as does very close performance monitoring – volatility requires vigilance.
• Loans: Low interest rates present exceptional planning opportunities for wealth transfer. Higher interest rates may also present planning opportunities, and relatively high-interest family loans may be refinanced more easily if and when rates drop than traditional commercial lines of credit or mortgages.
• Gifts: Simply transferring assets down a generation or more while those assets are priced lower than intrinsic value is a gift that keeps on giving, assuming the asset given appreciates in the hands of the donee.
• Fiduciaries: Review fiduciary appointments and identify succession plans for any high-risk individuals; similarly, review the estate plans for any high-risk family and friends.

Grantor Retained Annuity Trusts

There are two reasons to think about GRATs today:

• High interest rates flow through to GRAT “hurdle” rates, which decreases the likelihood of a successful GRAT – for those with GRAT “programs,” it is not a given that those programs should continue in their current state indefinitely.
• Volatility in an existing GRAT program requires vigilance in looking for freeze opportunities.

What Is a GRAT?

In general, GRATs are used to minimize federal estate and gift tax.

To create a GRAT, the grantor makes a gift to a trust. The trust agreement says that the trust will last for a certain number of years – by way of example, assume two years. The trust also says that the trustee has to pay an annuity back to the grantor (this is the “grantor retained annuity” part of the trust) over two years. After two annuity payments back to the grantor, anything remaining in the trust passes to a trust for the grantor’s descendants.

The grantor makes a gift to his descendants on the day he creates the GRAT, since the lucky descendants are entitled to get something (the GRAT “remainder”) after the two-year term of the trust. The value of the gift is the value of what the grantor put in the trust less the value of what he is required to take back through the annuities, since that is what the descendants are anticipated to receive.

Most modern estate planning attorneys structure GRATs so that the value of what the grantor puts in is roughly equal to the value of what he is required to take back, plus a “hurdle” which the IRS sets each month. If the assets in the trust appreciate at a rate greater than the hurdle, descendants receive assets free of transfer tax. This is sometimes referred to as a “zeroed-out” GRAT because the value of the gift is deemed to be zero.

Why GRAT?

Appreciation above a hurdle passes to descendants transfer-tax free. If the assets in the GRAT do not beat the hurdle rate, there are no negative tax consequences; the GRAT will just be fully depleted by making payments back to the grantor, and there will be nothing left to pass to the next generation at the end of the GRAT term.

Below is an example of a two-year GRAT funded with $2 million in the low interest rate environment we experienced in January 2013, when the hurdle rate was 1%.

The annuity amount in each case is calculated by paying just enough back to the grantor so that the value of the interest the grantor retains plus that low hurdle of 1%, is equal to what was put into the trust. If the value is equal to what was put in, then the “gift” to remainder beneficiaries is nothing, because using accepted IRS growth rates (again, very low at 1%), the anticipated amount to pass to the remainder beneficiaries is zero. These are commonly called “zeroed-out GRATs.”

For illustrative purposes, we ran two scenarios, one assuming 3% growth and one with 7% growth.

The bold number in each example is the amount passing to the GRAT beneficiary after two years, free of transfer tax or use of exemption, assuming the grantor survives the term. The GRATs were “zeroed out” as explained above, so no gift tax was due. The annuity in year two increases by 20%, which is permitted under the IRS regulations and leaves more in the GRAT in the first year to grow, which makes it more likely that the GRAT will succeed in beating the required IRS hurdle.

You may be thinking that the above picture looks much too rosy given the stock market appreciation we have experienced throughout 2024 as well as current relatively high interest rates. Today, the hurdle over which a GRAT must perform in order to transfer wealth to the beneficiaries is 5.6%. A high hurdle alone does not mean that a GRAT strategy should be abandoned. Rather, if you fund a GRAT (perhaps with a concentrated asset that experiences large swings in price), it just becomes even more important to monitor your GRATs and consider whether they may be so underwater that they are unsalvageable. In that case, the appropriate strategy is not to cross your fingers and hope the GRAT recovers; rather, it is much more prudent to cut your losses and start anew. This strategy of creating multiple GRATs and freezing those that have outperformed as well as those that have underperformed is discussed here.

Conclusion

Executing on any of the estate planning and wealth transfer opportunities mentioned in this article will require legal advice. These ideas focus on tax savings and, while impactful, must also be aligned with your goals at the intersection of family, wealth, and philanthropy. Transfers should not be made for tax savings alone, but only if they contribute to your broader values-based wealth plan.

If you would like to learn more, please contact your BBH relationship team.