How does a grantor retained annuity trust (GRAT) work?
Depends on growth versus the §7520 rate and on surviving the term
A GRAT is an irrevocable trust that pays you a fixed annuity for a set term, with the remainder passing to your beneficiaries. Under IRC §2702, a qualified annuity is valued using the §7520 rate, so the gift can be close to zero. Only growth above that rate passes to the remainder beneficiaries, and if you die during the term, all or most of the trust is included in your estate.
Reviewed by Ebot Mbi, CPA, EA · Last reviewed · Law and figures current as of September 17, 2026
Key takeaways
- The retained annuity must be a qualified annuity interest under §2702(b) and Treas. Reg. §25.2702-3.
- The gift is the trust's value minus the present value of the annuity at the §7520 rate for the month of transfer (5.4% for September 2026).
- Only the return above the §7520 rate passes to the beneficiaries.
- If you die during the term, Treas. Reg. §20.2036-1(c)(2) includes the amount needed to fund the annuity, often all or most of the trust.
- GRATs are grantor trusts, and remainder assets keep your basis.
What it is
A grantor retained annuity trust is an irrevocable trust to which you transfer assets while keeping the right to a fixed annual payment for a term of years. When the term ends, whatever is left passes to your children or to a trust for them.
Because you keep a valuable annuity, the taxable gift is only the value of the remainder, computed with IRS actuarial assumptions. Many GRATs are designed so that the annuity's value nearly equals the transfer, leaving a gift close to zero.
A GRAT is also a grantor trust, so during the term you pay the income tax on its income, and the trust's payments of your annuity are not taxable events. That tax payment is an additional, indirect way to reduce your estate, similar to the effect in an intentionally defective grantor trust.
What the law says
IRC §2702(a)(2)(A) values any retained interest that is not a qualified interest at zero when you transfer an interest in trust to a family member. A qualified annuity interest, under §2702(b)(1), is a right to receive fixed amounts payable not less frequently than annually. Treas. Reg. §25.2702-3 sets the requirements, including that annuity payments may increase by no more than 120% of the prior year's amount and that no additional contributions are allowed.
IRC §7520 requires the retained annuity to be valued using 120% of the federal midterm rate for the month of the transfer, rounded to the nearest 0.2%. The IRS publishes the rate monthly; it was 4.6% in January 2026 and 5.4% in September 2026.
If you die during the term, Treas. Reg. §20.2036-1(c)(2) includes in your gross estate the portion of the trust needed to produce the retained annuity, which in many cases is the entire trust.
Requirements and tests
The trust instrument must also prohibit the trustee from issuing a note or other debt instrument to satisfy the annuity (Treas. Reg. §25.2702-3(b)(1)(i)), and the annuity amount must be fixed at creation, subject to the 120% increase rule. If the assets are hard to value, the annuity can be stated as a percentage of the initial value, so an audit adjustment to the value also adjusts the annuity.
- A fixed annuity, stated as a dollar amount or a fraction of the initial value, paid at least annually.
- Annuity increases of no more than 120% a year; no additional contributions; no commutation.
- A fixed term; your survival of the term is required to keep the assets out of your estate.
- Annuity payments made on time, in cash or in kind, with in-kind payments valued by appraisal where needed.
- A gift tax return (Form 709) reporting the transfer and the value of the remainder.
How it works
You transfer assets you expect to appreciate. The trust pays your annuity each year, in cash or by returning assets. If the assets grow faster than the §7520 rate, the excess stays in the trust and passes to your beneficiaries at the end of the term. If they do not, the trust is used up paying your annuity and nothing passes, but you have used little or no exemption.
Families often use short-term GRATs, such as two years, and repeat them, which limits mortality risk and captures growth in volatile assets. Higher §7520 rates make it harder for the assets to outperform.
Assumptions: $5,000,000 transferred; two-year term; equal annuity paid at the end of each year; no mortality component (term-certain).; Annuity set so that the remainder's value is about zero at the §7520 rate: shown at an illustrative 4.0% and at 5.4% (the September 2026 rate).; Assets grow 8% a year (assumed, not predicted); no fees.
| Annual annuity at 4.0% | $2,650,980 |
|---|---|
| Remainder to beneficiaries at 4.0% | $317,961 |
| Annual annuity at 5.4% | $2,704,275 |
| Remainder to beneficiaries at 5.4% | $207,109 |
| Taxable gift in either case | About $0 |
| Remainder if growth is 0% | $0 (the annuity uses up the trust) |
At 8% growth, the GRAT passes about $208,000 at the September 2026 rate, or about $318,000 at 4%, not millions, and the amount rises or falls with actual performance.
Illustration only; not a projection of your results.
Risks and IRS scrutiny
The main risks are the grantor's death during the term, assets that underperform the §7520 rate, valuation of hard-to-value assets, missed or late annuity payments, and legal and appraisal costs. Because the trust is a grantor trust, the remainder assets carry your basis, not a stepped-up basis.
Who it is not for
This is not for estates comfortably under the $15,000,000 exemption, for assets unlikely to outperform the §7520 rate, for anyone who may not survive the term, or for anyone who needs the transferred assets' full value back.
It is also not a good fit for assets that produce no cash and are hard to divide, since paying the annuity in kind requires frequent appraisals.
How ebotCPA helps
We model the annuity, the remainder, and the result at the current §7520 rate under several growth scenarios, including zero growth. We track payments and prepare the Form 709. We coordinate with your attorney, who drafts the legal documents.
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.
We coordinate with your attorney, who drafts the legal documents.
Frequently asked questions
What happens if I die during the GRAT term?
Treas. Reg. §20.2036-1(c)(2) includes in your estate the amount needed to produce the annuity, which is often all or most of the trust.
What is the §7520 rate for September 2026?
5.4%, according to the IRS's published §7520 rate table.
What happens if the GRAT assets don't grow?
The trust pays your annuity until it runs out and nothing passes to the beneficiaries. You lose the setup costs but have used little or no exemption.
Is a zeroed-out GRAT allowed?
Under §2702 and Treas. Reg. §25.2702-3, the annuity can be set so that the remainder's value is at or near zero. Many planners leave a small positive gift.
Have facts like these?
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.