Financial Management

Rolling GRATs: Asset Selection Trumps Current Interest Rates

Financial planning during periods of relatively higher interest rates is certainly not elementary. In a low interest rate environment, the opportunities for wealth transfer seem boundless; one can seemingly draw from a myriad of strategies and have a high likelihood of success. A high interest rate environment, however, all but eliminates the effectiveness of such. In particular, strategies that involve intra-family loans or installment sales are negatively impacted by high interest rates. A Grantor Retained Annuity Trust (GRAT) is one of the few exceptions.

A GRAT does not seek to transfer the trust assets to the beneficiaries, but only the appreciation on those assets. Transferring only the appreciation, unlike other gifting techniques, can[1] allow for a transfer that is entirely gift and estate tax-free. For this reason, GRATs are particularly attractive for those who have already transferred assets equal to (or more than) their lifetime gift tax exemption of $12.92 million per person. GRATs may also be a good fit for those who are undecided on how they would like to use their lifetime gift tax exemption.

A GRAT is an irrevocable trust, yet it contains characteristics that are contrary to the very essence of an irrevocable trust. For example, by definition, in an irrevocable trust, the grantor relinquishes his or her ability to change it. However, for a trust to be considered a grantor trust for income tax purposes (i.e. the grantor pays the taxes incurred by the trust), certain features must exist. This includes, but is not limited to, grantor powers such as adding and changing the trust beneficiaries, or the power to substitute the trust assets with other assets of equal value. The ability to substitute trust assets in a GRAT should not be overlooked.

Functionally, the interest rate at GRAT inception is meaningful. You may be familiar with the Applicable Federal Rate (AFR), which is the minimum interest rate that the Internal Revenue Service allows for private loans and is published monthly based on current interest rates. GRATs utilize another monthly interest rate known as the Section 7520 rate. By definition, this is the AFR rate for determining the present value of an annuity. It is also known as the hurdle rate and can be perceived as the IRS projection for appreciation on the assets contributed to the GRAT.

For a GRAT to be successful, the trust assets must appreciate more than the annuity stream. This is why GRATs are particularly successful in a low interest rate environment when the Section 7520 rate is low. However, GRATs can still be fruitful in a high interest rate environment. The current market conditions could be viewed as favorable for GRAT creation due to the repressed prices of assets—most publicly-traded securities are trading at significant discounts due to lower valuations. As of this writing, the Section 7520 rate is 4.40%. A GRAT created today can successfully transfer wealth to the beneficiaries if the assets contributed appreciate more than 4.40% over the GRAT term.

So how do you go about actually creating a GRAT? First, identify the assets you wish to fund the GRAT with—generally either marketable securities, private company shares or real estate. Then you must engage an estate planning attorney to draft the GRAT agreement. This document will contain key provisions such as the funding amount, the annuity term, the annuity payments back to the grantor and the trust beneficiaries. It would be prudent to consider utilizing a “zeroed-out” [1] GRAT strategy, for which the annuity payments bake in the hurdle rate. These annuity payments will be considered in good standing with the IRS as long as they do not increase by more than 120% of the prior year’s payment. There’s an alternative Section 7520 interest rate applicable for these purposes (this rate is 4.45% as of this writing versus the 4.40% standard Section 7520 interest rate).

It’s important to note that success can be contingent on selecting the best assets to fund the GRAT, but an unsuccessful GRAT shouldn’t necessarily be considered a loss. If the contributed assets do not appreciate more than the hurdle rate, those assets are simply transferred back to the grantor. Keep in mind, however, that you will incur administrative expenses to implement the strategy, including, but not limited to, fees paid to the attorney who drafted the trust agreement and valuation expenses should you choose to contribute private company shares to your GRAT. While it may be tempting to fund a GRAT with family business stock, some experts opine that GRATs funded with marketable securities are more likely to succeed than their counterparts, as valuation expenses can be quite costly. A pre-initial public offering stock would be a notable exception.

Even in a high interest rate environment, there is one GRAT strategy that is highly likely to succeed. This strategy is known as “rolling GRATs”, which can be defined as a series of short-term (read: 2-year) GRATs, for which each subsequent GRAT is funded by the annuity payments from the preceding GRAT. This strategy reduces mortality risk versus implementing one longer-term GRAT, which is one of the key considerations for any GRAT. The grantor of a GRAT must survive the annuity term. Otherwise, the contributed assets and their appreciation are clawed back into the grantor’s estate. Rolling GRATs also spread out interest rate risk, as each subsequent GRAT would have a new hurdle rate.

Functionally, a rolling GRAT strategy would operate as follows:

  • Execute the trust agreement with a 2-year annuity term and a zeroed-out[1] annuity payment schedule. Assume an agreement date of March 15, 2023, a contribution of assets with a fair market value (FMV) of $2,000,000 and the current 120% Section 7520 hurdle rate of 4.45%. For your GRAT to be successful, the GRAT assets therefore must appreciate to $2,089,000 by March 15, 2025.
  • The first-year annuity payment, made on March 15, 2024, should be 47.47729% of the initial FMV of the contributed assets. This allows for a second-year annuity payment percentage to be 120% of the first-year annuity payment percentage and for both annuity payments to total the FMV which beats the hurdle rate ($2,089,000). Therefore, the March 15, 2024 payment is calculated to be $949,546.
  • If you funded your GRAT with marketable securities, you would calculate the FMV of the GRAT on March 15, 2024, and transfer shares with an FMV of $949,546 to a new GRAT with an agreement date of March 15, 2024, which also has a 2-year annuity term. The hurdle rate would be the Section 7520 interest rate on March 15, 2024. Should you have chosen to fund your GRAT with, for example, real estate family business stock, you would engage an expert to perform a valuation as of March 15, 2024, and transfer an interest with an FMV of $949,546 from the initial GRAT to the new GRAT.
  • Given that the first-year annuity payment percentage is 47.47729%, the second-year annuity payment should be 56.97271% of the initial FMV, which is 120% of the first-year annuity payment percentage and calculated to be $1,139,454. When you add both annuity payments together, they total $2,089,000, meeting the hurdle rate.
  • Should the FMV of your initial GRAT be greater than $1,139,454 on March 15, 2025, this would make it a successful GRAT. You would then apply the same exercise that was performed at the end of year 1, calculating the FMV of the initial GRAT on March 15, 2025 and transferring shares with a FMV of $1,139,454 to another new GRAT with an agreement date of March 15, 2025. The shares remaining in the initial GRAT after the second-year annuity payment can now be transferred to the GRAT beneficiaries free of gift and estate tax. Again, do keep in mind, should you have chosen to fund your GRAT with harder-to-value assets, you would need to obtain yet another appraisal as of the end of the initial GRAT term.  Avoiding the expense of obtaining three valuations for your initial GRAT (and then annually thereafter for each of the new GRATS) makes for a compelling argument to consider funding your GRAT with marketable securities rather than illiquid assets.


[1]: Only a “zeroed-out” GRAT eliminates all possibility of a taxable gift. A Zeroed-out GRAT is one where the present value of the annuity of the grantor’s retained interest is equal to the full value of the property initially transferred to the GRAT. Essentially, the hurdle rate is baked into the annuity payments.


Heeding early warning signs can transform business risk into success

The decline of a family business can be heartbreaking. Often the extended family loses much of its fortune and the financial security of future generations is at risk. Why does this happen, and, if you are a family member who is not running the business, how do you prevent the decline? Minority family shareholders as well as controlling owners can learn to identify early warning signs and take steps to implement solutions that will transform risk of decline into success.

Powerlessness and fear
A family business is subject to the same fluctuations as any other business. Today, especially, the pressures are intense because change happens faster. But an additional element is found in many family businesses: A single dominant figure often exercises effective control. Business problems are exacerbated when the controlling figure is an aging patriarch/matriarch or a successor who struggles to meet current challenges. Other family members, even if they have an economic stake, often lack visibility into the family business and feel powerless to do anything but worry.

Recognize hints of business decline
Fortunately, you can prevent the decline of the family business even if you do not control it. Here is the key: Your ability to sway the controlling family member improves considerably if you understand the dangers that are facing the business. To do this, you must watch for hints of business decline. These hints occur well before business distress.

While the onset of distress results in significant loss of value, there are earlier hints of business downturn. Unlike signs of distress, these hints are apparent at first only to business owners, who tend to ignore them. Some owners do not realize the implications. Others delude themselves that external factors will come to the rescue. On the other hand, if the company acts quickly, you can avoid a loss of value.

Among these earlier hints are financial warning signs:
• Appearance of new competitors
• Shift in buying or sale trends
• Increased importance of payment timing
• Deferral of capital expenditures
• Lack of innovation in products or methodologies
• Overreliance on an officer, supplier, customer, channel or trend

You may think you are too far removed from the business to be aware of such hints. Do not despair: You are not powerless. There are non-financial hints that you can discern, such as:
• No new blood in management
• Family or health demands prevent the controlling family member from focusing on the business
• No enthusiasm for finding new deals or strategies
• Lack of desire or resources to take the company to the next level

Persuade the controlling family member
After you have identified warning signs, how do you persuade the controlling family member to act? It is not easy to convince anyone to change course. To persuade a person in control is even harder. Hardest still is to convince a person in control who may have overcome obstacles that would have deterred others.

The heads of family businesses are often lone — in some ways heroic — figures. They are responsible for their families’ key asset. Their stubbornness and determination are their strength, but these qualities can also be a weakness if they fail to recognize and respond to business problems. The Romans understood that heroes should be honored but also cautioned. A slave would whisper to a Roman conqueror, “memento homo” — remember you are mortal (only a man). Somehow you need to caution the leader: “Every business is mortal. There are warning signs. You are not alone. We need to respond.”

So how do you do this? The etymology of “persuade” is instructive. The Latin word “suadare” means to “advise,” while “per” means “through, to completion.” To persuade, you need to advise — knowledgeably explain the danger signs and then offer a solution.

You have a great advantage: If the family business responds soon enough, there are a myriad of solutions in today’s economy. The options include:
• Addition or substitution of fresh management
• Introduction of new technology
• Adoption of a new pricing model
• Divestiture of a division
• Sale of the company
• Acquisition of a competitor
• Entry into new markets
• Vertical integration
• Modification of debt structure

To demonstrate the wide range of solutions, let us consider two of these options more closely. You could choose to advocate sale of the company as the ultimate way out. This is a valid solution if, for example, the family wants to monetize its assets or if a buyer has the resources to take the business to the next level. Owners who sell before business downturn becomes apparent to third parties reap the benefits of responding to the aforementioned early hints.

At the other extreme was an operationally profitable business with an unwieldy debt structure (a warning sign). I served as chief restructuring officer at this company. Management was motivated but was confronted with a debt burden that was too onerous for the fundamentally sound business. Instead of allowing the company to slide eventually into a bankruptcy, we engaged the lenders in rigorous negotiations. The separate liquidation analyses prepared by the lenders’ adviser and my team accorded and conclusively demonstrated that it was more advantageous for the banks to take a “haircut” than to drive the borrower into a liquidation. Heeding the warning signs led us to a solution — we renegotiated the debt structure and today the company is thriving. In these types of situations, you can transform risk into success by advocating for a balance sheet fix.

I want to stress a key point. The solutions I have provided are efficacious because they provide positive options to the controlling person. Author and physician Jerome Groopman writes in The Anatomy of Hope that “hope is one of our central emotions.” You can change the controlling person’s mindset by offering hope predicated on concrete ideas.

Based on the lives of his patients, Groopman distinguishes between optimism and hope:

“Many of us confuse hope with optimism, a prevailing attitude that ‘things turn out for the best.’ But hope differs from optimism. Hope does not arise from being told to ‘think positively,’ or from hearing an overly rosy forecast. . . .

"Hope is the elevating feeling we experience when we see — in the mind’s eye — a path to a better future. Hope acknowledges the significant obstacles and deep pitfalls along that path. True hope has no room for delusion.”

To persuade the controlling person, provide hope by offering compelling options grounded in reality.
Now that you have identified the hints of decline and found a solution, you need a procedure to bring about the desired result. Consider whether you are more likely to be successful in one-on-one discussion or if you need a formal mechanism to achieve your goal.

If you opt for a formal mechanism, the best vehicles for conflict resolution are those set up in advance of any problem. You can approach the board of directors. An established family council might provide a non-threatening forum for you to raise your concerns and seek resolution. A shareholder agreement could afford protections for minority or non-controlling shareholders. You may be able to force the issue if there is a buy-sell agreement in place. If there are no mechanisms in place, you can convene a formal family meeting or set up a family council. The last resort should be litigation. Litigation is always expensive and protracted — it is even worse in the context of family conflict.

Build family alliances
If you use the family council, family meeting or board of directors mechanisms, you will probably need support from other family members. You can build alliances by finding a financial solution that addresses the goals of the various family interest groups. This is not easy. You will have to approach the problem both methodically and creatively. First, determine what each person (or family interest group) really wants. Then try to develop scenarios that would satisfy these goals.

This may sound theoretical, so let me provide a “real life” example from which you can extract principles. A family inherited from its founder a real estate empire. Most of the children were in favor of selling the business because they wanted immediate distribution of funds. Opposing them were family members who were concerned about losing their employment in the family business. The next generation, the grandchildren, wanted a steady future income stream.

In a certain respect, the solution was complex. We designed a model that provided for a staged sale of the real estate holdings structured to ensure the following critical goals: Current employment continued for family members, the children received funds in the short term, and the youngest family members had a trust that provided for income over a long period. The sale cadence was extremely sophisticated: Properties could be sold only if they did not cannibalize revenues from locations retained for a longer period, positive cash flow had to be maintained throughout, and distributions were timed to meet the interests of the various parties. However, in another respect, the solution was simple. We identified and addressed the desires of each family interest group.

Transform risk into success
The good news is that, even if you do not have a control position, you can save the day. Recognize the warning signs, caution the controlling family member in an effective manner, offer hope by providing a business solution, implement (if necessary) conflict resolution mechanisms, and, if you seek family support, develop financial solutions that address the needs of each family interest group. Controlling and non-controlling family members alike can convert danger of decline into transgenerational growth and renewal.      

Sheon Karol is a managing director and management committee member of The DAK Group, an investment bank serving the middle market (

Copyright 2019 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact                                                            

It pays to plan for the worst

As I write this, rumblings of an impending recession are getting louder. In January, Deloitte released a survey of 147 corporate chief financial officers that found 55% expected a U.S. recession by the end of 2020. The CFOs’ optimism about their own companies’ prospects dropped to the lowest level in nearly three years, according to Deloitte’s CFO Signals report. The finance chiefs predicted lower business spending and higher labor costs.

With a new Congress in session, fallout from a government shutdown and candidates announcing plans to run for president in 2020, political uncertainty is also a factor to be reckoned with.

The United States has enjoyed a long period of economic growth. Now we may be heading into rough times. In your strategic planning sessions, are you discussing what-if scenarios? This may be a good time to consider diversifying, curtailing growth plans or reducing inefficiencies. Think about what you can do to reduce debt. On the other hand, if your business is a strong competitor, you might want to brainstorm about acquiring a weaker player in your marketplace.

Over the past year, corporate governance experts have criticized public companies’ emphasis on short-term results. Family businesses’ focus on investing for the long term is now being promoted as a model for public corporations to emulate. But family shareholders, who in good times are optimistic about sustaining the company for future generations to own, tend to view their investment more skeptically in a downturn.

Family members who rely on their dividend checks might be anxious about the prospect of lower profits. Their fear could manifest itself as mistrust of the business leader or the board. In the worst cases, family meetings can devolve into a blame game or shouting match. Relatives who need cash might start complaining loudly about the illiquidity of their investment in the family firm.

What can your family do to prevent family volatility from compounding the challenges of economic volatility? Here are two suggestions:

1. Beef up your family education efforts. Ask your financial adviser to lead a family education session on economic life cycles so everyone understands the situation. Investigate how your adviser could help family members with personal financial planning and risk mitigation. Enlist executives from the family company to explain the business strategy at a family meeting.

2. Focus on shared family values. Review the family’s history of surviving tough economic times and emerging stronger. Declare your commitment to each individual family member and emphasize the need for the whole family to pull together. Review your family code of conduct (or create one, if you don’t already have it) and explain the importance of level-headed decision making.

Smart business leaders recognize the importance of preparing their companies ahead of time to face a downturn. It’s just as important to institute a plan to prepare your family for the challenges of a recession.

Copyright 2019 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact