Benefits of intentionally defective grantor trust
It may seem hard to come up with a financial product with a name as unattractive as an “intentionally defective grantor trust.” Yet these days, in the world of estate planning, those words denote one sexy vehicle.
That’s because this aggressive strategy — which can be used to move money out of taxable estates and transfer gains to heirs tax-free — is especially appealing at a time like now, when asset values have fallen sharply and interest rates are near historic lows. * * *
The trusts are considered “defective” because they are subject to somewhat contradictory tax treatment. They remove assets from your estate — saving your heirs estate taxes in the process — while allowing you to continue paying income taxes on those assets, effectively making another “gift” to your heirs. Another benefit: Unlike some other popular trust strategies, these can also be used as part of a broader plan to pass assets to your grandchildren.
Defective grantor trusts can be structured in many ways. Typically, the strategy involves creating a trust and then lending it money to buy one of your assets — such as securities, real estate or a business interest — that you expect to appreciate significantly. In return for lending the trust money, you receive interest payments for a set number of years. The lower the interest rate, the less the trust must repay you — and the more your heirs will benefit. * * *
Defective grantor trusts can backfire. Unlike some other trusts, if your assets plunge in value, the trust is still on the hook to repay your loan. And that could mean more money from your pockets. * * *
Another big caveat: The IRS has never specifically blessed these trusts, which draw on two separate areas of the tax code * * *.