The Difference Between a GRAT and IDGT Trust

Estate planning for high-net-worth families often goes far beyond a simple will or revocable living trust. When it comes to reducing estate tax liability and transferring wealth efficiently to the next generation, two sophisticated strategies frequently come into play: the Grantor Retained Annuity Trust (GRAT) and the Intentionally Defective Grantor Trust (IDGT). Each structure has unique strengths, limitations, and ideal use cases depending on your specific goals, assets, and risk tolerance.

This article will walk you through the differences between GRAT and IDGT trusts in plain terms, explain some of their pros and cons, and offer guidance on which option may best suit your estate planning objectives.

If you’re considering one of these strategies — or already have one in place — it may be time to reevaluate your approach. Contact the wealth advisors at Avidian Wealth Solutions to help you make informed decisions that align with your legacy planning goals.

What is the difference between IDGT and GRAT?

Before diving deeper into the unique drawbacks and use cases of each strategy, here’s a simple comparison table to help illustrate how GRATs and IDGTs differ in structure, tax treatment, and planning objectives:

	GRAT	IDGT
Trust type	Irrevocable	Irrevocable
Tax treatment	Grantor for income tax, included in estate if grantor dies during term	Grantor for income tax, excluded from estate
Duration	Fixed term	Perpetual or long-term
Benefit to grantor	Annuity payments during term	None (grantor pays trust taxes)
Ideal assets	Highly appreciating, volatile assets	Steady-growth assets, business interests
Risk if grantor dies early	Assets pulled back into estate	No effect; remains outside of estate
IRS hurdle rate consideration	Must outperform Section 7520 rate	No IRS growth benchmark; growth accumulates freely
Gift tax	Zeroed-out possible	Gift tax applies on seed gift or sale valuation
Complexity	Lower	Higher (especially with installment sales)

What is a Grantor Retained Annuity Trust (GRAT)?

A GRAT is an irrevocable trust designed to transfer asset appreciation to beneficiaries while minimizing gift and estate taxes. The grantor contributes assets to the trust and retains the right to receive fixed annuity payments over a set term, typically 2 to 10 years.

The idea is that the assets in the trust will appreciate at a rate higher than the IRS’s Section 7520 assumed interest rate. At the end of the term, the remaining value (i.e., appreciation beyond the assumed rate) passes to the beneficiaries free of additional gift or estate tax.

Key features	Ideal use cases
Funded with appreciating assets (e.g., stocks, business interests)Grantor receives annuity paymentsNo gift tax if structured properly (“zeroed-out” GRAT)Beneficiaries receive remainder interest tax-free	Short-term wealth transferAssets expected to appreciate rapidlyDonors who want to retain some benefit from the assets during the trust term

GRATs are especially attractive in low interest rate environments, where the hurdle to beat the IRS assumed growth rate is lower. However, they come with key limitations, particularly if the grantor dies during the trust term.

What are the disadvantages of a GRAT trust?

• Mortality risk: If the grantor dies before the term ends, the remaining assets are included in the estate and the planning benefits are largely lost.
• Short-term focus: GRATs are better suited to short-term asset growth; they’re less effective for multi-generational transfers.
• No GST planning: GRATs typically can’t be used to leverage Generation-Skipping Transfer (GST) tax exemptions effectively.
• No additional contributions: Once established, you can’t add more assets to a GRAT; you would need to set up a new one.

What is an IDGT?

An Intentionally Defective Grantor Trust (IDGT) is also an irrevocable trust used to transfer wealth outside of the grantor’s estate. The “defective” part refers to a deliberate tax loophole: the trust is structured so that it is a separate legal entity for estate tax purposes, but not for income tax purposes.

This means the grantor continues to pay income tax on the trust’s earnings (which further reduces their taxable estate), while the assets grow inside the trust without being taxed again when passed on to heirs. IDGTs are often used with installment sales to further leverage tax benefits.

Key features	Ideal use cases
Assets grow outside of the estateGrantor pays income tax, allowing trust assets to grow unencumberedOften paired with a promissory note or installment saleCan be used for multi-generational planning	Long-term planning for appreciating assetsClients with significant income who can afford to pay taxes on trust incomeFamilies looking to transfer wealth with valuation discounts (e.g., business interests, FLPs)

IDGTs are highly flexible and can be designed to fit a range of estate planning needs, especially when paired with advanced valuation or generation-skipping strategies.

What happens to an IDGT when the grantor dies?

Unlike GRATs, which fail tax-wise if the grantor dies during the term, IDGTs offer more continuity:

• Assets remain outside of the estate if the structure is properly maintained.
• The grantor’s obligation to pay income taxes ends, and the trust begins to pay its own taxes.
• The promissory note (if one exists) becomes part of the taxable estate unless prepaid.
• IDGTs can be designed as dynasty trusts, allowing for wealth preservation over multiple generations.

It’s important to revisit trust terms and planning regularly, especially as health, tax law, and family dynamics evolve.

What is a disadvantage of an intentionally defective grantor trust?

The possible drawbacks of utilizing IDGTs are one reason why working with trusted professionals to deploy these powerful strategies is essential. 

• Income tax burden: The grantor must pay income taxes on trust earnings without receiving income from the trust. This can create liquidity issues if not properly planned.
• More complex setup: Especially when using an installment sale, IDGTs require precise structuring, accurate asset valuation, and compliance with IRS rules to avoid adverse consequences.
• Potential audit risk: Valuation discounts and installment sales may attract IRS scrutiny, especially if not supported by strong documentation.

How does an installment sale to IDGT work vs GRAT?

An installment sale to an IDGT is a powerful technique for shifting appreciating assets without triggering a large gift tax. Here’s how it typically works:

1. The grantor “seeds” the IDGT with a small gift (usually 10% of the sale value).
2. The grantor then sells appreciating assets (like a business interest) to the trust in exchange for a promissory note.
3. The note pays interest at the IRS minimum rate (AFR), and any appreciation beyond that accrues inside the trust tax-free.

The GRAT, by contrast, does not involve a sale or promissory note. The grantor simply contributes assets and receives back annuity payments based on the IRS 7520 rate. In short:

• IDGTs lock in the asset value at the time of sale (good for volatile markets)
• GRATs reset value annually if you “roll” multiple GRATs

Installment sale strategies have higher risk and complexity but greater upside potential in long-term planning.

GRAT vs IDGT: additional considerations

When deciding between a GRAT and an IDGT, many factors beyond tax efficiency should be evaluated. Here are five common considerations and questions that HNW families should explore:

1. How long do you plan to live in the asset transfer window?

If life expectancy is a concern due to age or health, an IDGT may be preferable since it doesn’t rely on outliving a fixed term.

2. What type of assets are being transferred?

GRATs are often better for volatile, appreciating assets (like public stocks), while IDGTs shine when transferring closely held businesses or discounted assets.

3. Do you want to reduce estate value through income taxes?

IDGTs allow the grantor to pay income taxes on behalf of the trust, reducing their taxable estate without gift tax implications.

4. How much complexity can you handle?

GRATs are relatively straightforward and low-risk, while IDGTs (especially those with installment sales) require more sophisticated legal and financial support.

5. Is multigenerational planning a goal?

IDGTs allow more robust GST tax planning and can be set up as dynasty trusts, enabling wealth to compound outside the estate for generations.

Is it time to reevaluate your GRAT or IDGT trust? Let’s talk.

At Avidian, we understand that estate planning is not a one-and-done process for families whose wealth profiles, business interests, and life goals evolve over time. If you’ve already established a GRAT or IDGT, now may be the right time to revisit the assumptions behind your strategy.

Questions we often help clients answer include:

• Are my current trust structures still aligned with my goals?
• Would a GRAT rollover or new IDGT be more efficient under current market conditions?
• How do new IRS rulings or interest rate changes affect my trust?
• Can I better integrate my wealth transfer strategy with charitable giving or succession planning?

The advisors at Avidian collaborate with estate attorneys and CPAs to create personalized, tax-aware wealth strategies. Whether you’re exploring GRAT and IDGT trusts for the first time or rethinking your existing plan, we’re here to help.

Let’s build a legacy that lasts — get in touch with Avidian at one of our office locations in Houston, Austin, Sugar Land, or The Woodlands today.

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• How to Use a Family Limited Partnership in Estate Planning
• 9 Risks of Naming a Family Member as a Business Successor
• What Happens to a Business when the Owner Dies?

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