Grantor Retained Annuity Trusts (GRATs): Wealth protection and tax efficiency for founders

Startup success can lead to massive personal wealth, but with that success comes a challenge: how to pass on valuable startup equity without triggering major gift or estate taxes.

Enter the Grantor Retained Annuity Trust, or GRAT. This little-known but IRS-approved strategy offers startup founders a way to transfer future appreciation to heirs while minimizing tax exposure. The catch? Planning ahead is crucial. You'll need to think about timing and structure and possess a deep knowledge of your company's growth trajectory.

Here we'll explain how GRATs work, why they're useful for startup founders and what to know before setting one up.

What is a GRAT?

A GRAT is a type of irrevocable trust that allows a founder (the "grantor") to transfer assets, including startup shares, while retaining the right to receive fixed payments over a set number of years. The payments are calculated according to a formula set by the IRS and don't change while the GRAT is in place. At the end of the term, whatever remains in the trust passes to heirs or other beneficiaries, often free of gift tax.

The IRS assumes that assets inside a GRAT grow at a specific interest rate set by the tax code — Section 7520. If the actual return exceeds this "hurdle rate," the excess value passes to beneficiaries without gift taxes.

To minimize the gift tax, GRATs are often structured as "zeroed-out," meaning the annuity payments are calculated to equal the initial contribution value. That locks in the early, low valuation of the startup, before a major funding round or IPO and enables founders to pass on that growth to heirs without using up any of the lifetime gift tax exemption.

Benefits of GRATs for founders

Few assets have the potential for explosive growth like early-stage startup shares. That's why GRATs are so compelling for tech founders.

Structured correctly, GRATs lock in low valuations and pass the upside to family members or trusts with little to no gift tax. Using a GRAT, you might transfer startup shares worth $1 million into a trust. If the company's value grows to $10 million during the GRAT term, most of that $9 million appreciation could pass to their children, tax free.

Although the assets leave the estate, founders can retain economic control during the GRAT term, which can vary from two to 10 years. You can continue receiving annuity payments during that time. The key is to fund the GRAT before a known valuation spike or liquidity event — timing that makes this tool powerful but tricky.

How GRATs fit into a founder's larger estate plan

Used strategically, GRATs help founders protect wealth across generations and build a durable legacy, but a GRAT shouldn't be a standalone tactic. It works best as part of a broader wealth transfer strategy that includes irrevocable trusts, valuation discounts and Qualified Small Business Stock (QSBS) planning.

Because GRATs rely on precise valuations, working with a team that understands startup equity — especially restricted or illiquid shares — is essential. GRATs can be layered across years (so-called "rolling GRATs") to continue capturing appreciation as a startup matures.

Risk considerations for founders

Founders should carefully evaluate several key risks that could impact the effectiveness a GRAT and that could significantly affect the anticipated tax and estate planning benefits if not properly managed:

• Mortality risk: If the grantor dies during the GRAT term, the assets may revert to their estate, undermining the tax benefit.
• Loss of control: Once assets are transferred into a GRAT, they are legally owned by the trust during the term. The founder might have some administrative control if serving as a trustee of the trust, but grantor can't reclaim the principal of the trust, aside from annuity payments. At the end of the term, any remaining assets pass to the beneficiaries.
• Cost and complexity: GRATs can be expensive to set up and manage. The valuation and legal fees can be significant, especially with illiquid or hard-to-value stock.
• Timing: A GRAT that starts too late, such as after a funding event or IPO, may offer little to no benefit.

Best practices for founders considering a GRAT

Founders exploring a GRAT should approach the strategy with careful planning and expert guidance to maximize its benefits. These best practices are especially important in the context of fast-growing, privately held companies:

• Act early: The best time to use a GRAT is before a valuation spike — not after.
• Structure smartly: Short-term GRATs of two to three years reduce mortality risk and make it easier to pivot as your company grows.
• Coordinate across strategies: GRATs should be aligned with your vesting schedules, QSBS qualification and other trust planning tools like IDGTs or dynasty trusts.
• Use the right experts: Engage attorneys and valuation professionals who specialize in high-growth, privately held companies.

Building a tax-efficient legacy with GRATs

For startup founders, GRATs are a savvy, IRS-approved method to build intergenerational wealth without handing a windfall to the IRS. Done right, they let you share startup success with your heirs without paying large gift taxes.

But GRATs aren't off-the-shelf solutions. Each one must be tailored based on your equity, timing, goals and broader estate plan. If you're navigating pre-IPO planning or considering legacy strategies, this is a tool worth exploring.

Want help exploring GRATs or other advanced wealth transfer planning tools? Connect with Citizens Private Bank.