What is the primary reason that a grantor retained annuity trust (GRAT) can be an effective estate planning tool for transferring appreciating assets?

The primary reason a grantor retained annuity trust (GRAT) can be an effective estate planning tool for transferring appreciating assets is its ability to potentially transfer future appreciation of those assets to beneficiaries with minimal or no gift tax. In a GRAT, the grantor transfers assets into a trust but retains the right to receive a fixed annuity payment each year for a specified term. The value of the gift, for gift tax purposes, is the present value of the assets transferred to the trust, less the present value of the annuity payments the grantor will receive. If the assets within the GRAT appreciate at a rate higher than the IRS's Section 7520 rate (the interest rate used to value annuities), the excess appreciation passes to the beneficiaries tax-free at the end of the trust term. The effectiveness of a GRAT hinges on the assets appreciating significantly during the trust term and the grantor surviving the term; if the grantor dies during the term, the assets are generally included in their estate. A GRAT allows for leveraging the gift tax exemption, as only the discounted present value of the remainder interest is considered a gift, potentially sheltering substantial asset growth from estate and gift taxes.