Why Rolling GRATs Deserve More Gratitude

In the past decade, historically low interest rates meant families could transfer wealth by making modest principal gifts rather than large ones. That’s because they could leverage the future growth of their assets using borrowed funds to boost future returns. Thanks to minimal borrowing costs, such “leveraged strategies” flourished in low-interest environments.

Today, interest rates have eased modestly from their peak, but they still reflect a somewhat restrictive Federal Reserve stance rather than a stimulative one. As a result, families continue to grapple with higher capital costs. Yet one strategy may prove resilient regardless of interest rate regimes: short-term “rolling” grantor retained annuity trusts (GRATs).

Higher Rates Raise the Bar

To understand how the interest rate environment impacts a GRAT strategy, let’s explore the mechanics of a single, long-term GRAT.

Creating a GRAT involves transferring assets to a grantor trust in exchange for fixed annual annuity payments for a set period. If structured properly, these payments are deemed “qualified interest” under the Internal Revenue Code and their present value is discounted by the Section 7520 rate in effect during the month of funding.¹ This discounted value is then subtracted from the donor’s initial contribution to the GRAT, with the remaining amount considered the donor’s taxable gift. Many estate planners aim to match the value of the annuity payments to the value of the assets, resulting in a “zeroed-out” GRAT, which minimizes gift taxes.²

How do interest rates factor in? The Section 7520 rate, often called the “hurdle” rate for zeroed-out GRATs, is linked to Treasury bond yields.³ The rate comes into play by setting the benchmark for how much wealth can be transferred to the next generation. If the donor survives the GRAT’s term, any remaining assets after the final annuity payment will flow to the donor’s beneficiaries (often, in a trust for the donor’s children).⁴

Put simply, higher interest rates mean a higher Section 7520 rate. This results in higher annuity payments back to the donor—and less wealth transferred to the next generation, all else being equal. What about using valuation discounts? While they tend to improve the efficacy of a leveraged strategy, they don’t help a single GRAT strategy much. That’s because the same discount applied when assets are contributed to the GRAT must presumably be taken when assets are paid back to the donor each year.⁵

Ultimately, higher prevailing interest rates mean that donors must be more discerning and strategic in their planning to ensure that their GRATs achieve their wealth transfer goals.

The Case for Short-Term Rolling GRATs

Amid today’s higher interest rates, a single GRAT might struggle. However, a series of short-term rolling GRATs funded with marketable stocks is likelier to thrive regardless of the interest rate backdrop. Here’s how:

• Initiation: The donor starts by contributing assets, such as marketable stocks, to the first of a series of two-year GRATs. This sets the stage for a continuous cycle.
• First Annuity Payment: One year after funding the initial GRAT, the donor receives her first annuity payment. This payment is typically made through an in-kind transfer of stocks, meaning the donor gets back some of the same stocks she initially contributed.
• Reinvesting in New GRATs: Immediately after receiving the annuity payment, the donor contributes those stocks to a new two-year GRAT. This process is repeated annually with each existing GRAT, creating a rolling cycle of contributions and annuity payments (Display).

If the stocks in any one GRAT fail to outperform the applicable Section 7520 rate, that GRAT fails. The donor simply receives her stocks back without penalty—and without using much, if any, of her gift tax exclusion. If the stocks in a GRAT outperform the applicable Section 7520 rate, the net proceeds flow to the donor’s beneficiaries, effectively transferring wealth.

Beating the Odds

When looking at any single GRAT in isolation, a high Section 7520 can be daunting. But our research shows that the true advantage of a rolling GRAT strategy doesn’t come from cobbling together small “wins.” Instead, a GRAT occasionally produces a one-time, outsized success.

For example, assume a donor established a two-year, zeroed-out GRAT with a $10 million portfolio of S&P 500 stocks on January 1, 2020, when the Section 7520 rate was 2%. Despite the market volatility during the pandemic, the portfolio would have returned 18.4% that year. In 2021, returns would have jumped to 28.7%, for a total remainder value of nearly $3.5 million.

Now imagine the Section 7520 rate was 8%—nearly twice the 4.4% rate in October 2024. Even then, the remainder value would have exceeded $2.4 million, a significant win. The bonus? Because a donor must outlive a GRAT’s annuity term in order for “wins” to pass to beneficiaries, short-term rolling GRATs reduce the mortality risk inherent in long-term GRATs.

An Evergreen Solution with Some Complexity

Given the stock market’s historical upward trend over time, a zeroed-out, long-term GRAT invested in stocks is likely to produce a win. Some estate planners prefer the simplicity of a single long-term GRAT over short-term rolling GRATs. But relying on a single long-term GRAT means the trust’s marketable stocks will follow one potentially volatile path of return.

Consider a scenario where capital markets experience a significant downturn in the early years of a long-term GRAT. Early returns weigh more heavily on the overall performance because a larger pool of assets is affected by the pullback. This increases the percentage of the current portfolio’s value that must be allocated to future annuities.

The short-term rolling GRAT strategy works because it breaks one potentially volatile period of stock returns into a series of independent, two-year paths. This approach captures wins and cuts losses without one period canceling the other out. Because a failed zeroed-out GRAT has no income tax consequence and uses almost no gift tax exclusion, a donor is left with only her wins flowing to beneficiaries.⁶

In an ever-changing interest rate environment, short-term rolling GRATs shine. Overall, by embracing the strategy, donors can navigate interest rate fluctuations with greater confidence, making it a nimble wealth transfer approach. That’s why, when it comes to GRATs, it’s clear they deserve our gratitude.