What is a Grantor Trust?

A grantor trust is one in which the grantor retains control of its income and assets.

Grantor trusts are a type of living trust that is created during the lifetime of the individual who creates it. The grantor typically is self-appointed as the trustee to maintain control over the assets. The grantor can then name successor trustee(s) in the event he or she becomes incapacitated or dies. The grantor also has the ability to state in the trust agreement who will become the successor trustee or how the successor trustee will be appointed.

Since the grantor retains the benefits and control over assets in the trust, the income and gains of the assets in the trust are taxed to the grantor and not to the trust. All revocable trusts that can be changed by the grantor over time are grantor trusts. The owner of a grantor trust may change the trust’s beneficiaries, manage stock options for the trust, control trust fund investments and completely undo the trust.

Upon the grantor’s death, the trust is converted into a non-grantor trust since the owner no longer is alive to benefit from the trust. The income and gains from the assets within the trust are taxable to either the trust or the trust beneficiaries, depending on whether they are distributed to the beneficiaries or retained by the trust. Distributions of the assets and the income they generate are distributed to the beneficiaries by the successor trustee(s) according to the terms of the trust agreement.

Types of Grantor Trusts

There are a number of different grantor trusts which are great tools for those planning their estate.

Grantor Retained Annuity Trust (GRAT)

A grantor retained annuity trust (GRAT) is an irrevocable trust used in estate planning that allows the individual to minimize taxes on large financial gifts and draw income from the assets. The grantor of a GRAT transfers assets to the trust. The trust will pay income to the grantor for a period of years. After that, the assets are distributed to or held in the trust for the benefit of other beneficiaries, who are usually the grantor’s children or grandchildren. The grantor pays income taxes on income and gains distributed to him or her and might owe a gift tax when the trust is created. A GRAT can transfer wealth to the beneficiaries at a greatly reduced estate and gift tax than if the assets were transferred directly.

“These are aggressive strategies,” says Bob Carlson of RetirementWatch.com. “They work well… when they’re done carefully.”

Intentionally Defective Grantor Trust (IDGT)

An intentionally defective grantor trust (IDGT) is a trust that is used to intentionally freeze the values of certain assets for estate-tax purposes. This trust is created with the intention that the grantor will continue to pay income taxes on the income and gains earned by the trust. The assets in the trust will grow tax-free since the grantor is paying the income taxes. When the grantor passes away, the assets are not included in his or her taxable estate.

Qualified Personal Residence Trust (QPRT)

A qualified personal residence trust (QPRT) is a type of grantor trust that allows the grantor to remove the value of a home from his or her taxable estate. The property is transferred to the beneficiaries of the trust (usually the grantor’s children or grandchildren) at a reduced estate and gift tax cost. A QPRT is most useful for those who have an expensive home or second home and want to pass it on while reducing estate and gift taxes.

Key Takeaways

• A grantor trust lets the individual retain control of the trust’s income and assets. Since the grantor still controls the assets within the trust, the income and gains are taxed to the grantor and not to the trust.
• Grantor trusts are revocable, but some irrevocable trusts can be grantor trusts for tax purposes.
• Grantor trusts usually require the individual to have enough income to cover taxes on the trust’s income and gains.
• Some variations of the grantor trust can be used to reduce estate and gift taxes.
• Grantors of basic grantor trusts hold the power to make changes in or revoke the trusts at any time.