I have to give credit for the title of this post to Wall Street Journal writers Mike Spector and Anne Tergesen. They used the term as a side bar in their recent article, Unusual Trusts Gain Appeal in Unusual Time.
In their article they discuss some of the many uses for a technique that is often difficult to explain, the “intentionally defective grantor trust”. The other day I was explaining to a client the three ways that an irrevocable trust can be taxed and how those three methods can be used to maximize income and estate tax savings. Although he was following what I was saying, I thought “there has to be a better way to explain this than a defective trust is good!”
That is where “Defective but Effective” comes in. Defective trusts are not effective estate planning tools, they are also highly efficient and flexible. In my office I often build this feature into my advanced planning irrevocable trusts even if we are not planning on using it currently. It allows us to “upgrade” the plan later if necessary.
Virtually any irrevocable trust, (asset protection trust, gift trust, generation skipping – dynasty trust, life insurance trust, etc.) can be an intentionally defective grantor trust. they are especially useful in Washington where gifting is favored due to our lower estate tax exemption and lack of gift tax. In Seattle we have many unmarried and same sex couples for whom the Defective but Effective trusts are just the ticket.