A Beneficiary Defective Inheritor’s Trust, also known as a “BDIT,” is one of the most powerful estate tax and asset protection strategies available to taxpayers. This trust is a third-party settled trust designed to give the taxpayer (who is both a trustee and the initial primary beneficiary of the trust) control and beneficial enjoyment of trust property such that the taxpayer can use and manage the trust assets without compromising the trust’s ability to avoid transfer taxes at the client’s death, and to protect the trust assets from the client’s creditors.
Popular estate planning tools such as grantor retained annuity trusts and intentionally defective grantor trusts offer many benefits. They enable you to leverage valuation discounts to reduce gift, estate and generation-skipping transfer taxes. And they allow you to “freeze” asset values at their date-of-contribution levels, protecting all future appreciation from transfer taxes.
These tools fully utilize the benefits of the grantor trust rules to generate additional estate planning benefits. The trust’s income is taxed to you, as grantor, allowing the assets to grow tax-free and preserving more of your wealth for future generations. Your payment of the tax on the trust income is basically additional tax-free gifts to your children or other beneficiaries.
Traditional trusts always suffer from one major disadvantage: you must relinquish the right to control, use, or direct the trust assets. That’s not the case with BDITs. You maintain control.
The BDIT’s benefits are made possible by one critical principle: Assets transferred by a third party (such as a parent) to a properly structured trust for your benefit enjoy transfer-tax savings and creditor protection, even if you maintain control over those assets. IRS rules prohibit you from transferring assets to beneficiaries on a tax-advantaged basis if you retain the right to use or control the assets. But those rules don’t apply to assets you receive from others in a beneficiary-controlled trust. The challenge in taking advantage of a BDIT is to place assets you currently own into a third-party trust.
This trust is especially useful for assets that are appreciating quickly in value, or assets that currently have a low value but are anticipated to rapidly increase in value in the near future. The BDIT allows the beneficiary to retain the right to manage and use assets held by the trust and to receive trust income and even principal in the amount needed for “health, education, maintenance, or support.” Thus, control of the assets, beneficial enjoyment, creditor protection, and estate tax benefits are all achieved through utilizing a BDIT.
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Of course, with all of the benefits offered by a BDIT there are many pitfalls to be aware of in structuring and funding the trust. Running afoul of any one of many tax provisions would be fatal to the BDIT and would nullify any anticipated benefits of the BDIT. That is why it is important to have experienced estate planners by your side throughout the process. Our goal at Castro & Co. is to partner with you in planning your legacy.
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