Understanding Intentionally Defective Grantor Trusts
Intentionally defective grantor trusts (IDGTs) are a type of estate planning tool that can help reduce the amount of estate taxes that are owed and yet still allow the owner to control the income that is generated. This article will explain IDGTs, how they work, and why you may need them in estate planning.
What Is an Intentionally Deficient Trust?
An intentionally defective grantor trust (IDGT) is set up so that the grantor pays the income tax while the trust's assets stay out of the grantor's taxable estate. Even though you create the trust and transfer your assets into it, the trust is designed to keep these assets from being taxed as part of your estate. You still pay tax on any income the assets earn, which is why the trust is called "defective."
How Can an IDGT Be Used in Estate Planning?
When you create an IDGT, you can deposit assets into the trust through sales or gifts. A popular method is to sell assets to the trust. This sale is often made through an installment sale, which means that the trust will make payments to you over time. Here’s what happens step by step:
Asset Transfer: You transfer ownership of the assets to the trust. This takes them out of your taxable estate.
Installment Note: You do not receive the payment in one lump sum but rather through a number of installments.
Income Tax: Even though the assets are in the trust, any income they generate will be subject to taxation.
Estate Benefits: The trust's assets can grow and be transferred to loved ones without increasing your estate.
This approach allows you to ‘freeze’ the current value of your estate and yet allow your assets to grow for your beneficiaries.
Why You Should Use an Intentionally Defective Grantor Trust
Using an IDGT in your estate planning is beneficial in the following ways:
Lower Estate Taxes: Since the assets are taken out of your estate, the overall value of your estate is reduced, and you may pay less in estate taxes when you die.
Asset Growth: The assets in the trust can increase in value over time. Any appreciation in value can then be passed on to the beneficiaries.
Tax Efficiency: Although you pay tax on the income, this is like a gift to your beneficiaries. You are able to minimize the size of your estate that is subject to taxation.
Flexibility: You can transfer assets to the trust by sale or gift, which provides you with some flexibility when planning your estate based on your individual circumstances and the market.
Important Things to Know
Although IDGTs have their advantages, there are some things you should know:
Income Tax Liability: You will continue to pay tax on the trust’s income, and this will be from you. This may be a concern if you have other sources of income.
Use of Installment Note: When you are selling assets to the trust, the use of an installment note is useful. However, the note’s provisions should be well thought out not to incur unnecessary tax consequences.
Planning with Experts: Since IDGTs are quite complex, it is crucial to engage the services of an experienced estate planning attorney and a tax consultant. They can assist in establishing the trust in the right manner and in a way that it will help achieve your future goals.
Is an IDGT Right for You?
An intentionally defective grantor trust is a valuable tool for people who wish to minimize estate taxes and yet ensure that their assets grow to meet their beneficiaries’ needs. By taking assets out of your estate and keeping the income tax on your shoulders, you can give your beneficiaries a better financial future.
At Falcon Wealth Planning, we are able to assist you in determining whether an IDGT is appropriate for your overall estate plan. We assist you in developing a plan that achieves your objectives and gives you confidence about the future.
If you are interested in finding out more about how an IDGT can help you, please contact us today. We are always here to assist you in achieving your financial goals.
*The content in this blog is for general informational purposes only and does not constitute personalized financial, investment, tax, or legal advice. Falcon Wealth Planning, Inc., a fee-only, true fiduciary, registered investment advisor, provides this information to give a broad understanding of financial concepts and strategies.