GRAT stands for Grantor Retained Annuity Trust. It’s an irrevocable trust used in estate planning to move appreciating assets to the next generation with little or no gift and estate tax. The person who sets it up, called the grantor, transfers property into the trust and receives fixed annuity payments back over a set number of years. If the assets grow faster than an IRS-assumed rate of return, everything above that threshold passes to the beneficiaries free of transfer tax. With the 2026 federal estate tax exemption set at $15,000,000 per individual, GRATs remain one of the more effective tools for wealthy families looking to transfer growth without burning through that exemption.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
The Three Roles and How the Mechanics Work
A GRAT has three participants: the grantor who creates and funds the trust, the trustee who manages the assets, and the remainder beneficiaries who receive whatever is left when the trust term ends. The grantor transfers assets into the irrevocable trust and, in return, keeps the right to receive annuity payments for a fixed number of years. Those payments can be a flat dollar amount or a fixed percentage of the initial value of what was transferred.
When the term expires, anything still in the trust belongs to the beneficiaries. The whole point is to split the transfer into two pieces. The annuity stream flows back to the grantor, which the IRS treats as the grantor getting value back. The remainder interest goes to the beneficiaries, and that is the only part counted as a taxable gift. If the assets perform well, the remainder can be worth far more than the modest gift the IRS recorded when the trust was funded.
The 7520 Hurdle Rate
Each month the IRS publishes a rate, known as the Section 7520 rate, that serves as the assumed rate of return for valuing annuity interests in trusts. It equals 120% of the federal midterm rate, rounded to the nearest two-tenths of a percent.2Office of the Law Revision Counsel. 26 U.S. Code 7520 – Valuation Tables For the first several months of 2026, the Section 7520 rate has ranged between 4.6% and 4.8%.3Internal Revenue Service. Section 7520 Interest Rates
Think of this rate as the hurdle the trust’s investments need to clear. The IRS assumes the trust assets will grow at the 7520 rate and calculates the annuity payments accordingly. Any growth above that assumed rate is excess appreciation that flows to the beneficiaries with no additional gift or estate tax. If the assets only match the hurdle rate, the annuity payments consume everything and the beneficiaries get nothing. If the assets underperform, the property simply returns to the grantor through the annuity stream and the trust washes out.
Lower 7520 rates make GRATs more powerful because the hurdle is easier to clear. When the rate is 4.6%, the assets only need to outpace 4.6% annual growth for the strategy to transfer wealth. In higher-rate environments, the assets have to work harder to generate any tax-free surplus. Timing the creation of a GRAT to coincide with a relatively low 7520 rate can meaningfully improve the outcome.
The Gift Tax Piece and the Zeroed-Out Strategy
The gift tax math is governed by IRC Section 2702, which provides special valuation rules for transfers of interests in trusts to family members. Under these rules, the taxable gift is not the full value of what was put into the trust. It equals the fair market value of the transferred assets minus the present value of the annuity stream the grantor retains.4Office of the Law Revision Counsel. 26 U.S. Code 2702 – Special Valuation Rules in Case of Transfers of Interests in Trusts The retained annuity qualifies for favorable valuation only if it consists of fixed amounts paid at least once a year.
The most common approach is a zeroed-out GRAT. The grantor sets the annuity payments high enough that their present value, calculated using the 7520 rate, nearly equals the entire value of the transferred assets. That drives the calculated remainder interest down to almost nothing, so the taxable gift at creation is negligible. A 2000 Tax Court decision in Walton v. Commissioner confirmed this technique is valid, rejecting an IRS regulation that would have inflated the gift value by accounting for the possibility the grantor might die during the term.
By zeroing out the GRAT, the grantor avoids consuming any meaningful portion of the $15,000,000 lifetime gift and estate tax exemption. The real wealth transfer happens through appreciation above the 7520 hurdle, and that appreciation passes to the beneficiaries entirely outside the transfer tax system.
What Happens If the Grantor Dies During the Term
The single biggest risk of a GRAT is that the grantor dies before the trust term ends. If that happens, a portion or all of the trust assets get pulled back into the grantor’s taxable estate for federal estate tax purposes. The retained annuity right is treated as an interest in the transferred property that did not end before death, triggering inclusion under IRC Section 2036.5eCFR. 26 CFR 20.2036-1 – Transfers With Retained Life Estate
The included amount is not necessarily the full trust value. The regulations calculate the portion of trust principal needed to generate the remaining annuity payments using the 7520 rate in effect at the date of death. In practice, this often means a substantial chunk of the trust comes back into the estate. A zeroed-out GRAT partly mitigates the damage because the grantor used little to no lifetime exemption setting it up. The estate inclusion returns the grantor to roughly the same tax position they started in; the family loses the planning opportunity but does not end up worse off than if the GRAT had never existed.
This mortality risk is why shorter trust terms are popular. A two-year GRAT carries far less risk of the grantor dying during the term than a fifteen-year GRAT.
Income Tax Treatment
A GRAT is treated as a grantor trust for federal income tax purposes. The grantor reports all income, gains, and losses from the trust on their personal return, as if they still owned the assets directly. The trust itself pays no income tax.
That creates a hidden bonus. Because the grantor bears the income tax burden personally, the trust assets grow without being reduced by tax payments. The grantor’s payment of the trust’s income taxes is not treated as an additional gift to the beneficiaries, so it effectively represents extra wealth shifted to the next generation on a tax-free basis. Over a multi-year term, this tax absorption can add up.
Which Assets Fit
The assets you put into a GRAT matter enormously. The whole strategy depends on the trust assets outperforming the 7520 hurdle, so the best candidates are assets with high appreciation potential: pre-IPO stock, interests in a rapidly growing private business, and concentrated stock positions expected to rise. Stable income-producing assets like bonds or dividend stocks are poor choices because they are unlikely to generate the excess growth needed to transfer meaningful wealth.
Illiquid assets like closely held business interests bring complications, because the trust still needs to make annuity payments. That usually requires distributing pieces of the asset itself or holding enough liquid assets alongside it to cover payments. Valuation discounts on closely held interests can work in the grantor’s favor at funding, since a lower initial value means a lower hurdle to clear, but the appraisal has to withstand IRS scrutiny.
Rolling GRATs
Rather than funding a single long-term GRAT, many practitioners use a rolling strategy: a series of short-term GRATs, typically two years each, where the annuity payments from one GRAT fund the next. When the first GRAT’s term ends, any remainder goes to the beneficiaries, and the returned annuity payments seed a brand-new GRAT. The cycle continues indefinitely.
Rolling GRATs offer two advantages. First, short terms minimize mortality risk. Second, they capture volatility more effectively. A single ten-year GRAT needs sustained outperformance over the full decade. A series of two-year GRATs can lock in gains from any period where assets spike, even if other periods are flat. Each GRAT that succeeds sends wealth to the beneficiaries; each one that fails simply returns the assets to the grantor to try again. The tradeoff is added legal and administrative cost for creating and maintaining multiple trusts.
Where GRATs Don’t Work Well: Grandchildren
One limitation catches people off guard: GRATs do not work well for transfers that skip a generation, such as gifts directly to grandchildren. The generation-skipping transfer (GST) tax applies to such transfers, and a grantor normally allocates GST exemption to shield the trust. A special rule prevents this allocation from happening during the GRAT term.
Under IRC Section 2642(f), GST exemption cannot be allocated to property that would be included in the grantor’s estate if the grantor died immediately after the transfer.6Office of the Law Revision Counsel. 26 U.S. Code 2642 – Inclusion Ratio Because GRAT assets are always includable during the term due to the retained annuity, the GST exemption allocation is frozen until the term ends. At that point, the exemption must be allocated based on the full value of the assets passing to the next trust or beneficiary, not the tiny taxable gift originally calculated. For a GRAT that performed well, that means burning a large amount of GST exemption to cover what could be a very valuable remainder. Most estate planners structure GRATs to benefit children and use other vehicles when the goal is to reach grandchildren.