What Is an Intentionally Defective Grantor Trust (IDGT)?
An Intentionally Defective Grantor Trust (IDGT) is a trust in which the grantor creates specific provisions to ensure that upon their death, any assets remaining in the trust will be taxed at one or more levels prior to being distributed to beneficiaries. IDGTs are an excellent estate planning tool for individuals who want to pass on significant wealth tax-free but plan on spending down most of their assets during their lifetime.
Why Would Someone Create One?
An IDGT can be a very effective way to reduce or avoid estate taxes, as well as gift taxes. The grantor can make direct contributions to the trust without having to worry about gift tax consequences, and any assets remaining in the trust after the grantor’s death will be taxed at a lower rate than if they were distributed to beneficiaries outright.
How Do You Set Up an IDGT?
The creation of an IDGT is a fairly complex process, and it is advisable to work with an experienced estate planning attorney to make sure everything is done correctly. Generally, the following steps are taken:
- The grantor must give the trustee discretionary power over distributions from the trust.
- The grantor must disclaim ownership of any assets that are contributed to the IDGT.
- Assets to be placed in the IDGT are transferred into a separate entity, such as a limited liability company or corporation, which is then granted a non-recourse note payable to the IDGT.
- The assets are transferred back into the trust.
- As long as future distributions from the trust are greater than any interest payments made on the non-recourse note, there will be no tax consequences for any distributions made from the trust after the grantor’s death.
What are the Benefits of an IDGT?
There are several benefits to creating an IDGT, including:
- Tax-Free Distribution
Assets remaining in the trust after the grantor’s death will be taxed at a lower rate than if they were distributed to beneficiaries outright.
- Reduced or Eliminated Estate Taxes
The estate tax exemption amount is currently $5.45 million per individual, so an IDGT can be a very effective way to reduce or avoid estate taxes altogether.
- No Gift Taxes
The grantor can make direct contributions to the trust without having to worry about gift tax consequences.
The trustee has discretion over distributions from the trust, so they can be tailored to the needs of each beneficiary.
Drawbacks to Creating One
There are a few potential drawbacks to setting up an IDGT, including:
- Complex Process
The creation of an IDGT is a complex process, and it is advisable to work with an experienced estate planning attorney to make sure everything is done correctly.
- Increased Administrative Costs
There may be additional administrative costs associated with setting up and maintaining an IDGT.
- Potential for Fraud
The grantor should take steps to ensure that the trust is administered properly and that no assets are stolen or misused.
Who Should Consider Setting Up an IDGT?
An IDGT can be a very effective estate planning tool for individuals who are willing to leave substantial wealth to charity after their death. However, the IDGT is not beneficial in all situations, and it may not make sense for individuals with smaller estates or those who expect to spend most of their money before they pass away.
The Bottom Line
An IDGT is a complex estate planning tool that can be very beneficial in some situations, but it may not make sense for many individuals. Before setting up an IDGT, the grantor should work with an experienced estate planning attorney to ensure that everything is done correctly and legally.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.