Most people don’t walk into an estate-planning attorney’s office and say:

“I’d like a trust that eventually runs out of money.”

Usually, it’s the opposite.

“I want this money protected forever.”

“I want my children to have it.”

“I want something left for my grandchildren.”

“I want to make sure nobody can touch it.”

All perfectly reasonable.

Then your attorney introduces an idea that sounds completely backwards:

What if we intentionally create a trust that is expected to shrink—and possibly disappear—over time?

Excuse me?

I’m paying lawyers to create a trust, paying accountants to file tax returns, moving assets around, and explaining this structure to my family…

and the plan is for the trust to fail?

Welcome to the strange but potentially useful world of the Intentionally Defective Inheritor’s Trust, commonly called an IDIT.

And before anyone panics, “defective” doesn’t mean somebody drafted the trust after happy hour.

The defect is intentional.

In fact, it’s the whole point.

First, What Is an IDIT?

An IDIT is an estate-planning strategy designed to address a surprisingly common problem:

A parent wants to give a child money, but doesn’t necessarily want the child to own that money outright.

Maybe the parent wants the assets protected.

Maybe the child is young.

Maybe the child is financially inexperienced.

Maybe the child is married to someone the parent trusts about as much as a gas-station sushi buffet.

Maybe the parent simply understands that circumstances change.

So instead of leaving $2 million directly to the child, the parent leaves the $2 million in trust.

So far, nothing unusual.

But an IDIT adds an important feature.

The beneficiary is generally given a carefully structured withdrawal right—often designed around the beneficiary’s federal gift and estate tax exemption.

That withdrawal right can potentially cause the beneficiary to be treated as having certain ownership rights for transfer-tax purposes.

And that’s where things get interesting.

Why Would Anyone Want the Trust to “Fail”?

Because sometimes the goal isn’t to preserve the trust forever.

The goal is to preserve it while it is useful.

Think about that distinction.

Suppose Dad leaves $5 million to Daughter.

Dad has two choices.

Option One: Daughter receives $5 million outright.

Congratulations, Daughter.

Unfortunately, Daughter may now have $5 million directly exposed to whatever problems life delivers.

Divorce.

Creditors.

Lawsuits.

Bad investments.

Bad business partners.

Bad judgment.

Very persuasive people with excellent PowerPoint presentations.

Or Dad can use:

Option Two: Daughter receives the benefit of $5 million through a properly structured trust.

Now the assets potentially have protections that wouldn’t exist if Dad simply handed her a check.

But perhaps Dad doesn’t want to create a dynasty trust intended to exist for the next 150 years.

Maybe the family doesn’t need that.

Maybe the administrative burden isn’t justified forever.

Maybe the tax planning works better if the trust gradually moves into Daughter’s taxable estate.

That’s where a trust designed to eventually “fail” can actually succeed beautifully.

The Word “Fail” Is Misleading

When people hear that a trust might eventually fail, they imagine catastrophe.

The trustee absconded to Monaco.

The lawyer forgot to sign something.

The IRS kicked down the door.

Grandma accidentally named the cat as trustee.

That’s not what we’re talking about.

The better way to think about an IDIT is as a trust with a planned life cycle.

At the beginning, the trust may provide substantial benefits.

Over time, the beneficiary’s withdrawal rights and the changing value of the trust may alter the economics.

Eventually, depending on the structure and what the beneficiary does, the trust could become depleted or cease to serve a meaningful purpose.

That isn’t necessarily a drafting failure.

It can be the intended result.

The trust did its job.

Let’s Meet Dad and Daughter

Dad has an estate worth $15 million.

Daughter is 40.

Dad loves Daughter.

Dad does not love Daughter’s husband.

This is not unusual.

Dad has never actually said, “I don’t like your husband.”

Dad says things like:

“He certainly has a lot of ideas.”

And:

“Is that business still operating?”

And:

“I just hope you’re keeping your finances separate.”

Estate planners are fluent in this language.

Dad dies and wants Daughter to benefit from $5 million.

He could leave it outright.

But if Daughter later divorces, has creditor problems, or is sued, Dad would prefer that the inheritance not become an easily reachable personal asset.

So Dad leaves the $5 million in trust.

Daughter can receive distributions under the trust terms.

The trustee manages the assets.

The trust provides a degree of separation between Daughter and the inherited wealth.

So far, Dad is happy.

Or at least as happy as Dad can be under the circumstances, given that he’s dead.

Then Comes the Tax Problem

Asset protection is only one part of estate planning.

Taxes matter too.

One of the great benefits of inheriting appreciated property is the potential basis adjustment at death under Internal Revenue Code Section 1014.

Suppose Dad bought stock for $100,000 decades ago and it is worth $1 million when he dies.

If the applicable requirements are satisfied, the basis may generally be adjusted to the asset’s fair market value at Dad’s death.

That can eliminate a substantial amount of built-in capital gain.

Wonderful.

But now imagine that the assets remain outside Daughter’s taxable estate for the rest of her life.

When Daughter dies decades later, assets excluded from her gross estate generally don’t receive a new §1014 basis adjustment merely because Daughter died.

And that can create an odd situation.

We may have worked extremely hard to keep assets out of Daughter’s estate even though Daughter has plenty of unused estate-tax exemption.

We avoided an estate tax that wasn’t going to exist—and potentially sacrificed an income-tax basis adjustment that could have been extremely valuable.

That may not be brilliant planning.

Estate Tax Planning Has Changed

For decades, estate planning often operated under a simple assumption:

Estate tax = bad.

Therefore:

Keep assets out of the estate.

That made enormous sense when estate-tax exemptions were much lower relative to family wealth.

But modern planning can require more nuance.

If a beneficiary has substantial unused estate-tax exemption, having certain appreciated assets included in that beneficiary’s gross estate can potentially be beneficial.

Why?

Because estate inclusion may create the opportunity for a basis adjustment at death.

So instead of automatically asking:

“How do we keep this asset out of Daughter’s estate forever?”

we should sometimes ask:

“Do we actually want this asset outside Daughter’s estate forever?”

That is a very different conversation.

Enter the IDIT

An IDIT attempts to navigate these competing objectives.

We want:

Protection while Daughter is alive.

But we may also want:

Estate inclusion when Daughter dies.

Those objectives sound contradictory.

And that’s exactly what makes the planning interesting.

A carefully structured withdrawal right can potentially cause some or all of the trust assets to become includible in Daughter’s gross estate for federal estate-tax purposes.

If properly structured and appropriate under the circumstances, that inclusion may allow qualifying appreciated assets to receive a basis adjustment at Daughter’s death.

So Dad’s inheritance potentially gets the benefit of:

Trust protection during Daughter’s lifetime

plus

potential estate inclusion and basis adjustment at Daughter’s death.

That’s the trick.

We’re not trying to avoid estate inclusion at all costs.

We’re trying to use it intelligently.

But Why Does the Trust Shrink?

Here’s where the “trust designed to fail” concept comes in.

Depending on how the withdrawal power is structured and exercised or allowed to lapse, portions of the trust can become subject to different tax treatment.

Over time, the beneficiary may have the ability to withdraw increasing amounts.

If Daughter actually exercises those withdrawal rights, assets leave the trust.

The trust gets smaller.

Eventually, she could theoretically withdraw everything.

Trust balance:

$0.

Did the trust fail?

Not necessarily.

For twenty years, perhaps the assets received meaningful trust protection.

The investments grew.

Daughter matured.

Her marriage stabilized—or ended.

Her children became adults.

Her financial circumstances changed.

The estate-tax landscape changed.

The trust accomplished what Dad wanted during the years when those protections mattered most.

Then it disappeared when it was no longer needed.

That’s not failure.

That’s retirement.

Think of It Like a Cast

If you break your arm, the doctor puts it in a cast.

Nobody says:

“This cast needs to remain on my arm for the next 75 years.”

The cast exists because it serves a purpose during a particular period.

Eventually, the arm heals.

The cast comes off.

You don’t stand in the doctor’s office screaming:

“THE CAST FAILED!”

It succeeded.

Its usefulness ended.

Some trusts can be viewed similarly.

We have developed an almost emotional attachment to the idea that a successful trust must exist forever.

But longevity isn’t necessarily the measure of success.

A trust is successful if it accomplishes the client’s objectives.

Sometimes that means 100 years.

Sometimes that means 20.

Sometimes that means creating a structure that deliberately changes as the beneficiary’s circumstances change.

The Creditor-Protection Angle

This is where careful drafting and state law become extremely important.

A trust established by someone else for a beneficiary can potentially offer creditor protection that the beneficiary wouldn’t have if the beneficiary owned the assets outright.

But withdrawal rights complicate that analysis.

If Daughter has an immediate, unrestricted right to withdraw $1 million, a creditor may be very interested in that fact.

Very interested.

So you cannot simply announce:

“Great! We’ll give Daughter the right to withdraw everything, obtain estate inclusion, preserve complete creditor protection, get a basis adjustment, pay no tax, and everyone goes home early.”

Estate planning rarely gives you every benefit simultaneously.

The scope of the withdrawal power, whether it is exercised, whether it lapses, applicable federal transfer-tax rules, and applicable state creditor law all matter.

This is sophisticated planning precisely because we’re balancing competing objectives.

What About the Famous “5 and 5” Rule?

This is another concept that can enter the conversation.

Federal transfer-tax law provides special treatment for the lapse of certain withdrawal powers up to the greater of $5,000 or 5% of the trust assets, commonly called the “5 and 5” power.

That sounds simple.

It isn’t.

The tax consequences of powers of withdrawal and their lapse can involve Sections 2041, 2514, and related rules.

Whether a lapse creates a taxable transfer, whether assets become included in an estate, and how much is included depend on the specific drafting and facts.

In other words:

Do not read “5 and 5 power” on the internet Friday night and amend Grandma’s trust Saturday morning.

There are professionals for this.

Let them earn their money.

Why Not Just Give Daughter a General Power of Appointment?

Good question.

Another way to intentionally cause estate inclusion can be to give the beneficiary a general power of appointment over trust property.

That can potentially cause the property subject to the power to be included in the beneficiary’s gross estate.

And in some circumstances, that may be exactly the appropriate solution.

The IDIT concept is interesting because withdrawal rights can potentially create a more dynamic structure.

The appropriate technique depends on the client’s objectives, the trust assets, beneficiary circumstances, creditor concerns, estate size, tax laws, and applicable state law.

There is no universal magic clause.

If there were, estate-planning lawyers would have much shorter documents.

They do not.

When Might an IDIT Make Sense?

Consider a family where Mom has significant wealth.

She wants to leave $4 million to Son.

Son is financially responsible and has an estate of his own worth only $2 million.

Mom wants Son’s inheritance protected rather than distributed outright.

But Son is unlikely to have a taxable estate.

A traditional trust might keep Mom’s $4 million outside Son’s estate forever.

That sounds wonderful until you ask:

Outside an estate tax that Son probably wouldn’t owe anyway?

Meanwhile, assume those assets grow from $4 million to $10 million during Son’s lifetime.

If they remain outside Son’s estate, the family may miss an opportunity for another basis adjustment when Son dies.

Depending on the assets, that could translate into substantial future capital-gains tax.

An IDIT-style approach might allow the family to preserve trust benefits during Son’s lifetime while intentionally creating some degree of estate inclusion.

The “bad” estate inclusion becomes potentially useful.

Tax planning has officially entered its rebellious phase.

Who Should Not Use This?

Not everyone.

If the beneficiary already has an estate large enough to face substantial estate tax, deliberately pulling additional assets into that estate may be exactly the wrong strategy.

If creditor protection is the overwhelming concern, broad withdrawal rights may undermine the objective.

If the beneficiary is financially irresponsible, giving significant withdrawal rights may be dangerous.

If the beneficiary has addiction issues, serious creditor exposure, an unstable marriage, or other circumstances requiring long-term protection, a trust designed to become accessible may be inappropriate.

If the trust holds assets with little appreciation potential, the basis-planning benefit may not justify the complexity.

And tax laws change.

Frequently.

Sometimes dramatically.

Today’s brilliant strategy can become tomorrow’s continuing-education seminar entitled:

“What We Were All Doing Wrong Five Years Ago.”

The Bigger Lesson: Stop Assuming Every Trust Should Last Forever

This is what I find most interesting about IDIT planning.

It challenges a basic assumption.

Clients frequently believe that the strongest estate plan is the one that locks everything up for the longest possible period.

But estate planning isn’t a competition to see who can control money furthest into the future.

The goal should be flexibility.

Tax laws change.

Families change.

Marriages change.

Asset values change.

Children mature.

Businesses are sold.

Exemptions rise.

Exemptions fall.

A trust drafted when your daughter is 25 may still be operating when she’s 75.

Those are not the same person living under the same circumstances.

Why should we automatically assume the same restrictions make sense for both?

Sometimes “Defective” Is Exactly What You Want

Estate planning has some truly terrible marketing terminology.

“Intentionally defective.”

“Crummey powers.”

“Grantor retained annuity trust.”

“Generation-skipping transfer tax.”

Nobody responsible for naming these concepts was trying to sell tickets.

But behind the terminology is an important idea:

Sometimes a provision that appears undesirable in isolation creates a very desirable overall result.

Estate inclusion isn’t always bad.

A trust ending isn’t always bad.

A beneficiary having access isn’t always bad.

And a trust becoming depleted isn’t necessarily a failure.

The question is whether the structure accomplished what we wanted while it existed.

The Bottom Line

An IDIT isn’t appropriate because someone wants a defective trust.

It’s potentially appropriate because estate planning involves balancing competing objectives.

We may want to protect an inheritance from creditors and divorce.

We may want to avoid probate.

We may want professional management.

We may want flexibility.

At the same time, we may not want to keep those assets outside the beneficiary’s taxable estate forever—particularly when the beneficiary has unused estate-tax exemption and the assets have significant unrealized appreciation.

In that situation, intentionally creating estate inclusion can potentially turn something estate planners traditionally tried to avoid into an advantage.

And if the trust ultimately shrinks or disappears?

Maybe that’s okay.

Maybe the trust wasn’t designed to last forever.

Maybe it was designed to protect assets during the period when protection mattered, adapt as circumstances changed, and eventually get out of the way.

A trust that lasts 100 years isn’t automatically successful.

And a trust that eventually disappears isn’t automatically a failure.

Sometimes the smartest estate plan is the one that knows when its job is done.

Even if the document describing that perfectly sensible strategy insists on calling it “intentionally defective.”

Estate planners really do need better marketing.

This article is for general informational and entertainment purposes only and does not constitute legal, tax, financial, or estate-planning advice. IDITs, powers of withdrawal, estate inclusion, basis adjustments, creditor protection, and related transfer-tax issues are highly dependent on the trust language, applicable state law, the beneficiary’s circumstances, and federal tax law. Anyone considering this type of planning should work with qualified estate-planning and tax professionals.