Here’s how uber-rich pass wealth to heirs tax-free when markets are down

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A lousy stock market is often no reason for investors to cheer. But for the uber-rich, it may offer a route to lower estate taxes down the road.

That’s because one type of trust gives them better odds of shifting some wealth to their children, grandchildren or other heirs tax-free when markets are down — but a subsequent rebound is expected, according to estate planners.

A grantor-retained annuity trust — or “Grat”— facilitates tbenefit.

In basic terms, the wealthy put assets like stocks in a privately held business into the trust for a specified time, maybe two, five or 10 years. Afterward, any investment growth passes to their heirs and the owner gets back the principal.

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By shifting any future appreciation out of their estate, the wealthy can avoid or reduce estate taxes at death. The investment growth becomes a tax-free gift to heirs. Absent growth, the asset simply passes back to the owner without a transfer of wealth.

Depressed assets that are likely to “pop” in value over the trust’s duration, therefore, yield the highest likelihood of success.

The S&P 500, a barometer of U.S. stocks, is down about 24% year to date — making it a ripe time to consider a Grat, estate planners said.

“It’s reasonable to believe the market will improve over the next two years,” Megan Gorman, founder and managing partner of Chequers Financial Management in San Francisco, said of trusts with a two-year term. “We will likely have significant appreciation pass to beneficiaries.”

Strategy used by Mark Zuckerberg, Oprah Winfrey

Mark Zuckerberg, co-founder and CEO of Meta Platforms, in July 2021.
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The Grat technique makes the most sense for households subject to estate tax, experts said.

The federal estate tax is a 40% levy on estates valued at more than $12.06 million in 2022. The taxable amount is double that figure, or $24.12 million, for married couples.

Twelve states plus Washington, D.C., also have a state-level estate tax, the amounts and thresholds of which vary, according to the Tax Foundation.

Some of the nation’s richest people and well-known business scions have leveraged Grats, according to reports. They include Michael Bloomberg; Facebook parent Meta co-founder Mark Zuckerberg; Sheldon Adelson, the late casino magnate; the Walton family of Walmart fame; Charles Koch and his late brother, David Koch; fashion designer Calvin Klein; Laurene Powell Jobs, the widow of Apple founder Steve Jobs; media mogul Oprah Winfrey; Lloyd Blankfein, senior chairman of Goldman Sachs; and Stephen Schwarzman, chairman and co-founder of the private equity firm Blackstone.

“It’s the one-tenth of 1% of society to whom this is really applicable,” Richard Behrendt, an estate planner based in Mequon, Wisconsin, and a former estate tax attorney at the IRS, said of the trusts. “But for that segment, I think it’s a golden opportunity.”

The estate-tax threshold is scheduled to be cut in half starting in 2026, absent an extension from Congress. A Republican-passed tax law in 2017 doubled the estate-tax threshold to around its current level but only temporarily.

The looming deadline may mean individuals with roughly $6 million estates (or $12 million for married couples) may weigh a wealth transfer now too, experts said.

Why rising interest rates are a headwind

Jerome Powell, chairman of the U.S. Federal Reserve, on Sept. 23, 2022.
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But rising interest rates pose a challenge.

That’s due to the complex inner workings of these trusts. Investment growth must technically exceed a certain threshold — the “7520 interest rate,” also known as the “hurdle” rate — to pass tax-free from one’s estate.

The 7520 rate, set monthly, is currently 4%, up significantly from 1% in October 2021. It’s risen as the Federal Reserve aggressively increases its benchmark rate to reduce high inflation.

Here’s an example of how this applies to a grantor-retained annuity trust. Let’s say investments in a two-year trust grew by 6% over that time. A trust pegged to the hurdle rate in October 2021 would let 5% of the overall growth pass to heirs; however, that would fall to 2% for a trust established this month.

“The hurdle rate is up 400% in one year,” said Charlie Douglas, a certified financial planner based in Atlanta and president of HH Legacy Investments. “I think the strategy still has some merit, but there’s a bit more drag on [it].”

And while the technique makes sense when there’s a significant market downturn, it’s tough to say how soon stocks will rebound, he added.

“Calling the low on it is always difficult,” Douglas said.

Sophie Tremblay

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