How Billionaires Manage to Pass Their Money Tax-Free to Their Heirs
Harrison Pierce is a writer and a digital nomad, specializing in personal finance with a focus on credit cards. He is a graduate of the University of North Carolina at Chapel Hill with a major in sociology and is currently traveling the world.
We already know billionaires are not just like us. First of all, they have billions of dollars. Second of all, they don’t have to pay taxes like normal people. And now we are learning that they will be able to pass the great trait of tax avoidance to their children. This is nepo babies and then some!
Here are some of the ways billionaires pass wealth to the heirs tax-free.
Grats: what are they?
Grats. Get to know this word. You will be hearing it a lot in this article and you can impress people at parties with your knowledge and vocab. Grat is short for “grantor-retained annuity trust,” which allows the ultra-wealthy to put their assets, like stocks, into the trust for a designated time. It could be anywhere from two to 10 or more years. After that period is up, the owner of the Grat gets back the principal, and any appreciation goes to their heirs.
Grats are so popular among the world’s millionaires and billionaires to move future appreciation out of their estate, which helps limit the amount of estate taxes at death. You can bet new billionaire Rihanna is doing this for baby whatever his name is (she s too famous to even reveal her son’s name so she definitely has a grat or two for him.) This appreciation is then considered a tax-free gift to their heirs. If the asset does not appreciate for whatever reason, the initial investment just goes back to the owner.
Experts say that now is a fantastic time to consider a Grat, as stock markets are down but are expected to improve over the next few years. This would indicate the possibility of significant appreciation that billionaires could pass down to their heirs.
Keep in mind that Grats are the most beneficial for those wanting to avoid estate tax, which is 40% on estates valued at $12.06 million or more. If you are in one of 12 states or Washington, D.C., you also have to deal with a state-level estate tax. Grats are used by Mark Zuckerberg, Oprah Winfrey, the senior chairman of Goldman Sachs, and more.
own more wealth than 50% of the world combined.
Rising interest rates make Grats more complicated
Grats are far more complex than they sound. There is something called the “7520 interest rate,” also called the hurdle rate, which outlines how much growth an investment needs to have to be eligible to pass tax-free. The rate is set monthly and is 4.60% as of January 2023. Compare this to October 2021, when the hurdle rate was just 1%.
What does all this mean? If a billionaire had a two-year trust that grew 7%, only 2.4% could currently pass tax-free to their heirs, compared to 6% a little over a year prior. Interest rates are skyrocketing to help curb high inflation, but this is not good news for billionaires. Trying to figure out when is the best time to use Grats is always a gamble, as you don’t know how long it’ll take for interest rates to go down and stocks to go back up.
How this applies to everyday people?
one-tenth of the top 1% have figured out how to pass wealth to their heirs tax-free effectively. However, this might not make a ton of sense for those households that are not valued at multi-million dollars. Even if you are not avoiding a hefty estate tax, you can take these principles into your financial life.
Hiring a financial planner can be beneficial regardless of your current wealth. These financial planners know the ins and outs of the billionaire world like the back of their hands and can advise you on wasting money on taxes.
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Grats might not make sense for everyone, but they absolutely help those looking to pass on wealth to children or grandchildren tax-free. Rising interest rates pose a unique problem, as timing is everything with this strategy. If you put your assets in a Grat too early, the hurdle rate puts up a significant barrier. If you avoid the hurdle rate and wait too long to place assets in a Grat, you risk having minimal stock growth if the market has already recovered. Ultimately, it is all a calculated guess to see when it will have the most impact.