Tier One - GRATs and CLATs: How Life Insurance Supercharges These Legacy Planning Tools

For our clients focused on legacy, philanthropy, and minimizing estate taxes, we consistently see two proven strategies rise to the top: Grantor Retained Annuity Trusts (GRATs) and Charitable Lead Annuity Trusts (CLATs). Both vehicles offer exceptional opportunities for tax-efficient wealth transfer. But when paired with life insurance, their potential for impact, both financial and philanthropic, grows exponentially.

Let’s look at how GRATs and CLATs work, compare their strategic uses, and discover how life insurance enhances both structures to deliver greater certainty, liquidity, and leverage.

GRATs: Shifting Appreciation, Minimizing Tax

A GRAT allows a grantor to contribute appreciating assets into a trust and receive fixed annuity payments for a set number of years. At the end of the term, any remaining value (above the IRS’s assumed interest rate) is transferred to beneficiaries, gift-tax free or at a deeply discounted value.

The IRS §7520 rate determines the hurdle rate: the assumed return the trust must beat to generate a gift. In a low-interest environment, it’s easier for the trust’s assets to outperform this rate, allowing more appreciation to pass to heirs with little or no gift tax impact.

How Life Insurance Enhances a GRAT Strategy:

• Wealth Replacement: The grantor may use annuity payments received from the GRAT to purchase life insurance outside of their estate, typically inside an Irrevocable Life Insurance Trust (ILIT). This helps "replace" the value of the assets transferred to heirs, providing tax-free liquidity at death.

• Asset Leveraging: If the GRAT outperforms the IRS hurdle rate, that appreciation passes to heirs. Meanwhile, the death benefit of the life insurance policy magnifies the total wealth passed on.

• Liquidity Planning: If a GRAT involves illiquid assets, the life insurance policy can provide beneficiaries with the liquidity to cover taxes or diversify holdings without a forced sale.

  
  

CLATs: Doing Good While Doing Well

A CLAT is a “split-interest” trust that pays a fixed annual annuity to a designated charity, such as a Donor Advised Fund (DAF), for a period of years or the life of an individual. After the charitable period ends, remaining assets go to the grantor's heirs.

CLATs are particularly compelling in a low-interest rate environment. The lower the IRS §7520 rate, the greater the present value of the charitable annuity, therefore reducing the taxable value of the remainder interest going to heirs.

There are two types of CLATs:

• Non-Grantor CLATs: Offer a gift tax charitable deduction but no income tax deduction to the grantor. Trust income is taxed to the trust.

• Grantor CLATs (G-CLATs): The grantor receives an upfront income tax deduction for the present value of the annuity stream going to charity but must pay income taxes on all trust income during the CLAT’s term.

  
  

Using Life Insurance in a CLAT Strategy

While CLATs are formidable on their own, integrating life insurance, particularly fully funded or paid-up policies, adds predictability and enhances both charitable and family outcomes.

Key Benefits:

1. Predetermined Outcomes: When a CLAT is funded with life insurance, the charity receives guaranteed annuity payments and heirs receive a guaranteed death benefit - independent of market volatility.

2. Tax-Efficient Transfer: Since the policy’s death benefit is not part of the grantor’s estate and the CLAT structure avoids gift tax on remainder interests, heirs receive wealth free of estate and gift taxes.

3. Charitable Deduction Leverage: For G-CLATs, the grantor receives an income tax deduction for the actuarial value of the charity’s annuity interest, often up to 30% of AGI (and 60% for direct gifts). Excess deductions can carry forward for five years.

4. Low Net Cost: For clients in top income brackets, the cost of a CLAT contribution may be as little as 50 cents on the dollar after factoring in the charitable deduction.

   
   

A Real-World CLAT Illustration

In one case, a couple (husband, 67; wife, 61) funded a lifetime CLAT with $3 million composed of cash, an annuity, and a life insurance policy. The charitable annuity beneficiary was a donor-advised fund. The trust made modest annual distributions to charity and a large balloon payment upon the insured’s death.

If the wife dies at age 91:

• The DAF receives $4.265 million.

• The heirs receive $8.88 million, tax-free.

• The net cost of the $3 million contribution, after tax savings, was approximately $1.5 million.

• Compared to a taxable investment returning 4.5% annually, this structure generated 60% more wealth to heirs, at lower risk, while making a substantial charitable impact.

  
  

Strategic Considerations and Planning Tips

• Zero-Out Structures: A GRAT or CLAT can be structured so that the present value of the annuity payments (to the grantor or charity) equals the value of the contribution - minimizing gift tax.

• Shark-Fin CLATs: These feature modest payments to charity in early years and a large balloon payment at the end - maximizing time for assets to grow.

• Avoiding Charitable Split-Dollar Risks: Rather than having the CLAT purchase a policy and pay ongoing premiums (which can trigger IRS scrutiny), it's often safer for the grantor to contribute a fully funded or paid-up policy.

• Mortality Risk in G-CLATs: If the grantor dies prematurely, a portion of the upfront charitable deduction may be subject to recapture. Using life insurance ensures that the trust can meet its charitable obligations regardless of lifespan.

  
  

GRAT vs. CLAT: Which Strategy Is Right?

Feature	GRAT	CLAT
Primary Beneficiary	Heirs	Charity (then heirs)
Grantor Receives Income?	Yes (annuity)	No (in CLATs)
Income Tax Deduction?	No	Yes (for G-CLATs only)
Gift Tax Efficiency	Yes (via zero-out technique)	Yes (especially in low-rate years)
Ideal Funding Asset	Volatile, appreciating assets	Bonds, annuities, or insurance
Common Enhancer	ILIT-owned life insurance	Paid-up life insurance in trust

Doing Good Feels Great!

At Life Insurance Strategies Group, many clients rely on GRATs and CLATs in their estate planning. While GRATs focus on shifting appreciation out of the estate, CLATs layer philanthropy into the plan and offer immediate income tax benefits when structured as G-CLATs. When paired with life insurance - either inside the trust or as a parallel wealth replacement strategy - both vehicles become even more powerful.

For high-net-worth individuals seeking to leave a legacy, reduce transfer taxes, and support the causes they care about, GRATs and CLATs paired with well-structured life insurance are hard to beat.

Remember, we do not sell products.  We help our affluent individual and institutional clients make decisions involving complex life insurance transactions.  If we can help you, reach out to us at www.lifeinsurancestrategiesgroup.com.