In the high finance environment that we all live in, you don’t have the luxury to not safeguard your money. Traditional approaches are often not enough, your assets are still exposed to the risk. Another road to look at is the Beneficiary Defective Irrevocable Trust (BDIT) – a more “involved” approach for those who want more.
Both internal and external wealth protection is well understood at Dominion. As we recognize the limitations of conventional methods, we help our customers find workable solutions. A BDIT is one such solution. Let’s discuss.
Understanding the Basics of a BDIT
Frankly, a Beneficiary Defective Irrevocable Trust is complex. The core idea is actually surprisingly simple. It’s a special kind of irrevocable trust that protects your assets from creditors and reduces estate taxes.
Let us first address the elephant in the room: “defective.” In the realm of trusts, this is not a bad thing. As it happens, it’s the reverse. One specific tax clause that helps you is the “defect.”
What Does It Do?
The defect enables you to not only pay income taxes on the trust’s assets, thereby reducing the size of your taxable estate but also the trust’s assets can grow tax-free. It’s like using your own money to pay down what you owe later but protecting those assets from potential claims.
Here’s how it works: A trusted third party like a close family member or friend creates the BDIT. They will give you a small initial amount and call you (the client) both the beneficiary and the trustee. This allows you a tremendous degree of control over trust assets.
Now, for some essential terminology:
Grantor Trust
This is a trust where you, as the creator, have some power over the trust’s assets. If you have a BDIT, you will be responsible for paying income taxes on the trust’s earnings, which, as we said, is a good thing for reducing your taxable estate.
Ascertainable Standard
This means the particular standards for making distributions from the trust. These are usually restricted to things like health, education, maintenance and support.
Testamentary Power of Appointment
Testamentary Power of Appointment is the power to appoint the beneficiaries of the estate. It means, after you die, you can decide who gets the assets tied up in the trust. Your heirs will be your chosen beneficiaries instead of a default one provided by the law.
Once you understand these basic elements, you’re one step closer to understanding the potential of a BDIT.
How a BDIT Works
Making a BDIT calls for accuracy and is a multi-step approach. Here is a basic breakdown:
Third-Party Creation
The Beneficiary Defective Irrevocable Trust is created by a trusted person, often a family member or a close friend. The third party then seeds the trust with a nominal amount (normally $5,000).
The Client Is both Beneficiary and Trustee
The third party then records that you, the client, are the trustee and beneficiary of the BDIT. This dual role is crucial. You will receive distributions from the trustee as the beneficiary. Since you’re the trustee, you have all the power to run the business of the trust effectively.
Sale of Assets to the BDIT
The magic really begins here. You sell things to the BDIT for a promissory note. This note is essentially an IOU stating that the BDIT will pay you back over time. It gives you a steady flow of money and moves your assets into the trust in the right way.
Third-Party Guarantor and Promissory Note
A third-party guarantor of the promissory note guarantees the transaction’s validity. The guarantor, usually another trust set up for your descendants, backs the note, usually guaranteeing at least 10 percent of the sale price. This step legitimizes the arrangement one step further.
Remember though, these steps are an overview, slightly simplified. Each one has intricate legal and financial considerations in which an expert must advise.
And that’s where Dominion comes in. We have the expertise and BDIT knowledge to see us through any challenge and ensure that your BDIT is set up to a structure to suit your specific practice.
Advantages of a BDIT for UHNWIs
You’ve put in the work to create your wealth. It’s now about making sure it stays protected and works as hard for you as you worked for it. BDITs offer several distinct advantages, especially for those with substantial assets:
Tax Advantages
Taxes can erode wealth significantly, we all know. By its nature, a BDIT is a very effective means of avoiding both income and estate taxes. You pay income tax on the trust’s earnings, thereby reducing your taxable estate.
Less of your wealth goes to the tax authorities, and more goes to your recipients. Your inheritance also becomes stronger, as the trust’s assets grow tax free.
Creditor Protection
It’s to protect your assets from creditors. A formidable addition of a BDIT layer of defense. Now they’re held by an irrevocable trust, and thus the creditors looking to satisfy judgments against you personally won’t ever be able to touch them.
It’s peace of mind knowing your wealth is protected from the unknown.
Maintaining Control
Unlike some asset protection strategies that require you to relinquish control, a BDIT allows you to maintain a great deal of control over your assets. Making investment choices and managing trust funds in line with your aims and objectives defines your role as the trustee.
It also means that your wealth continues to work for you, even within the protective structure of the trust.
Protection in Divorce Proceedings
Divorce is simply another way to say one’s relationship is over, and just as relationships can be complex and emotionally charged, divorces can be, too – and can have profound financial consequences. A BDIT can provide for greater protection to your assets over a prenuptial agreement.
Putting assets into a BDIT prior to marriage provides one more level of protection by establishing a definite separation between personal and marital property if one of you later files for divorce.
A BDIT is basically a whole system of wealth preservation. The fact is, it’s not just about avoiding your creditors or lowering your taxes, it’s about your legacy living on. It is to protect what you have created and to take the reins on your financial destiny.
Issues and Possible Negative Effects
BDITs have clear benefits. We’ve seen that. But what about the negatives? Dominion promotes openness. We cannot therefore avoid discussing the negative, either.
The Estate Tax on the Promissory Note
Remember the promissory note you get when you sell assets to the BDIT? When you die, that note might be subject to estate taxes. We take the time to carefully assess and plan for this so as to minimize any impact on your overall estate.
Administrative Requirements
BDITs are specific about the rules and regulations. If proper administration is done, the trust is expected to achieve its goal. It can be as simple as record keeping to a lot of detail and following certain procedures.
Stepped-up Basis Potential Loss
Assets held in a BDIT may not receive a “stepped-up” basis for income tax purposes at your death. The result: Your beneficiaries could owe more capital gains taxes down the road if they sell those assets.
Limited Administrative Guidance
BDITs are intended to be tax law-compliant, but there isn’t quite as much official IRS guidance on them as there is for most other types of trusts. In other words, we rely on our thorough knowledge of tax law and well-thought-out planning to get your BDIT right.
But we know this can be quite daunting. Such concerns and challenges are ones we at Dominion have the experience to overcome. We collaborate with you to create a tailored BDIT strategy that incorporates these factors and is in keeping with your longer-term objectives.
Why Dominion Is Right for BDITs
To protect your money, you need experience. Building a reputation on asset protection is what Dominion is all about. Knowing high-net-worth individuals and families, we understand the subtleties that come along with the role and know that a blanket strategy won’t cut it.
That’s why we tailor every single BDIT we create. Our strategy is built to fit your individual situation, objectives and risk tolerance.
We match our tax lawyers, tax advisors, and financial professionals to your goals and needs – we all work together to deliver the most effective and efficient BDIT possible.
We also have a global network. We have a presence in the major financial centers and asset protection jurisdictions around the globe, putting us in a position to avail ourselves of a great number of solutions and strategies.
At Dominion, we work differently. We are not tied to one legal system, so we are free to use many tools and methods to protect your money.
It’s Time to Take Control of Your Legacy
A Beneficiary Defective Irrevocable Trust is a very useful instrument for safeguarding your assets and guarantees your legacy lasts. That is not a do-it-yourself project, however. It has to be done meticulously, under professional direction, and well-controlled.
BDIT wealth governance solutions from Dominion help you overcome the challenges of a BDIT and achieve your financial goals. If you would like to start the discussion, get in touch with us today.
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