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How to use a beneficiary defective inheritance trust

Farm & Family: This type of trust allows a beneficiary to receive discretionary distributions from the trust.

Mark Balzarini

February 9, 2024

2 Min Read
oncept photo of U.S. dollar bills growing from the soil
PROTECT ASSETS: A lot of work has made your estate what it is — sometimes the sweat of multiple generations. The use of a beneficiary defective inheritance trust can ensure the assets don’t dry up. amenic181/Getty Images

With the potential changes to the federal estate and gift tax exemption, we are discussing various planning options with clients. The beneficiary defective inheritance trust is an example of one option that may prove helpful to some clients.

This trust is designed in such a manner that the beneficiary of the trust sells assets to the trust while allowing the beneficiary to receive discretionary distributions from the trust.

The trust is set up by a third-party grantor who is called a nominal grantor. This grantor essentially seeds the trust with a nominal amount of cash or other assets. The grantor retains no power or control over the trust, and because they have no power or control of the trust, it is not taxed to them, and the trust assets are not included in their estate.

The trust will name a beneficiary who has the right to withdraw the assets from the trust for a short period of time. This right to withdraw is needed so the beneficiary has a present interest in the trust assets.

Protect assets

The beneficiary will then sell assets to the trust. Generally, the assets sold to the trust are expected to grow in value or can be discounted because of lack of control and marketability. The beneficiary sells the assets on a promissory note. The beneficiary must charge interest on the note, with the interest rate equal to or higher than the applicable federal rate.

By selling the asset on a promissory note, the value of the asset is locked in at the purchase price plus the interest earned on the note. After the sale, the asset is no longer included in the beneficiary’s estate. All that remains owned by the beneficiary is the promissory note.

The trust is drafted in such a manner that the beneficiary is considered the grantor of the trust for income tax purposes. Because of this, the beneficiary does not recognize income or gain on the sale of the assets to the trust.

The trust can be designed to provide the beneficiary with control over the management, investments and distributions. Even with this control, the assets are still protected from the beneficiary’s creditors because the beneficiary does not have direct ownership rights to the assets.

Many times, this trust is drafted as a multigenerational trust, providing rules and direction on the distribution of the assets for many years. This helps protect the assets from future creditors, spendthrifts and estate taxes.

Read more about:

Estate Planning

About the Author(s)

Mark Balzarini

Mark Balzarini is an attorney at law with Hellmuth & Johnson PLLC. Contact him at [email protected].

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