Irrevocable Trusts Explained
An irrevocable trust is a trust where the grantor relinquishes all control over it, and therefore it cannot be modified or terminated without the permission of the beneficiary or beneficiaries. It is unchangeable, or as the term denotes, irrevocable. This is different from a revocable trust, where the grantor can amend, terminate or modify the trust while he or she is alive and competent. Revoking a trust involves turning over the trust’s assets to the grantor (settlor) , and hence a trust is not an alternative instrument to a will. A trust operates outside of a will and typically does not have any sort of required format. Writing a will does involve following some very specific guidelines that are typically determined by state law.
One reason why an irrevocable trust may be such a popular choice for estate planning is that a revocable trust does not provide some of the key benefits that an irrevocable trust does, nor does it accomplish some of the main objectives. An irrevocable trust can benefit the owner of a company or corporation wishing to keep a business going after his or her death, as the lifetime beneficiary of the trust is likely also the key person running the company. An irrevocable trust can also eliminate estate taxes if the grantor of the trust no longer has any control it.
The Fundamental Parts of an Irrevocable Trust Agreement
At its simplest, an irrevocable trust agreement includes the basic components: The first step requires naming the grantor, also known as the trustor, settlor, or donor. This is the first immediate step in creating an irrevocable trust as its creation does not occur until the grantor transfers the property to the trust. The trust language must name the grantor as the initial trustee, and while generally unnecessary, it may be wise for an irrevocable trust to name a back-up trustee if the grantor were to pass away or become incapacitated.
After the grantor and trusts names are decided, the next step is naming the beneficiaries. Beneficiaries can be individuals, organizations, living things, and more. In addition to naming the main beneficiaries, the legal agreement may need to include contingent beneficiaries to receive benefits in the event that the main beneficiaries do not survive. In general, the main beneficiaries will receive income generated by the irrevocable trust, not the principal.
The irrevocable trust document must include the terms and conditions by which the trustee will manage the trust property, when and how the beneficiaries will receive principal and income, and what will happen to the remaining principal after the beneficiaries have died.
These terms and conditions dictate when a distribution occurs once a specified event, such as reaching a specific age, occurs. It also includes how long the irrecoverable trust lasts, how the purchased assets will be acquired by the trust, and whether the beneficiaries have a right to income generated by the trust and, if so, under what terms.
Before creating an irrevocable trust, consult with an estate planning attorney.
Pros and Cons
The main advantage of using an irrevocable trust is asset protection. A properly structured irrevocable trust can prevent your assets from falling into the hands of your creditors. Under an irrevocable trust, you would also be protected from the claims of future bankruptcy creditors. In addition, a properly structured irrevocable trust is also beneficial for tax purposes. It may reduce federal gift and estate tax liability. An irrevocable trust may reduce state and local income tax liability, as well. An irrevocable trust could also qualify your estate for a full estate tax charitable deduction under Internal Revenue Code Section 2055(a).
One major disadvantage of an irrevocable trust is that you cannot modify the irrevocable trust agreement once it is established. In other words, once you place your assets in the irrevocable trust, you will no longer have direct control over the management of the assets. Any changes to the irrevocable trust agreement would have to be made by a court order. Hence, a judge may alter the terms agreed to and intended "ex post facto" (after the fact).
How to Draft an Irrevocable Trust Agreement
While a revocable trust is simple to set up, an irrevocable trust may be more complex and is generally best left to the lawyers, who will know how to start it off on the right foot. A very brief introduction to the irrevocable trust agreement process, however, will help you respect your lawyer’s time and lower your costs.
At first it might seem that a trust is essentially like a will—and it is in many ways. But there are two main things that make a trust different: A trust is legally distinct in its operation, even though it’s similar to a will as a part of the estate planning process. When you make a trust, you’re setting the rules for the distribution of your property after you die—but the arrangement itself needs to be laid out clearly for a trustee to manage after your death. While your trust document may resemble a will in function, it’s usually a good idea to draft it using a template or an example and then take it to a lawyer for revision. It can sometimes be difficult for a non-lawyer to know whether they’ve covered the necessary bases for a trust because there are so many variables. For this reason, it’s a good idea to find a sample or template that’s as close as possible to your situation and then to make any alterations your specific circumstances require. In addition to a sample document template, there are some basic pieces of information you’ll need. The trust agreement should specify: This list is not exhaustive, of course; there are many other provisions that a trust may include depending on the needs of the individuals creating the document. In any case, it’s a good idea to put down as much relevant information as possible in the template. Very careful drafting from the beginning of the process can help a lawyer create an effective document quickly and easily. Your next step is to take your template to a lawyer for review. If any provisions are vague, a lawyer will be able to help you specify them more clearly. In addition, a lawyer will ensure that the provisions you’ve included don’t violate any laws—something that can sometimes be difficult to do without legal training, as those laws vary by state or locality.
How to Adapt Your Trust Template
While most trust templates will provide a good starting point for your agreement, there are a number of other factors which you may want to take into account in order to customize the trust for your specific needs. In many cases, you will have to consider the family situation of both the person creating the trust (the "settlor") and the potential beneficiaries. What goals are you hoping to achieve by creating the trust? Are there particular provisions that you need in order to protect your beneficiaries? These are just a few of the questions that you will need to answer in this section .
For example, if one of the beneficiaries is a minor, you will need to have provisions for a trustee to handle distributions and to block access to the principal until the beneficiary reaches a certain age. If a beneficiary has creditor problems, special needs issues or addiction problems, you will need to craft the language in a way that will allow you to give them as much as you want without allowing creditors or others to get that money. By contrast, if someone has had a large inheritance already, you may not want to give them any inheritance through a trust, so you may want to lock that in and give access only to someone else until the beneficiary reaches an appropriate age.
Pitfalls to Watch Out For
Common mistakes when using an irrevocable trust agreement template include:
The first mistake is when the template does not conform to state law. An example of this would be a trust that tries to push back the age of trust accounting to and inclusion in estate tax returns to age 35. That is against the law and is a common mistake trustors make. The second mistake is when the template does not incorporate the wishes of the trustor. A good example of this would be when the trust automatically distributes income and certain portions of principal to something such as a spouse. The most common mode of directive for Wilhelm clients is the application of the Net Income Standard, but sometimes, clients have other wishes. Another mistake is the inclusion of boilerplate clauses that don’t apply to your needs or desires. For example, you should not include a no-contest clause that does not meet your intent strictly.
State Laws and Legal Issues
As irrevocable trusts often serve specific purposes like Medicaid eligibility planning or estate tax minimization, the law regarding their operation can be complex. Irrevocable trusts are governed by both national and state laws. The Internal Revenue Code is the principal federal law that governs irrevocable trusts. However, state law can also have a significant impact on how these trusts are set up and operated. Notably, many states have adopted what are known as the Uniform Trust Code (UTC) and the Uniform Prudent Investor Act (UPIA), which outline various legal requirements relating to how trusts must be drafted and executed.
The UTC is a comprehensive set of rules governing the formation and administration of trusts. While the UTC has not been adopted by every state, it has been adopted in one form or another in 55 jurisdictions. The UTC generally requires trusts to use certain language or else be administered in accordance with certain statutory provisions. The UPIA addresses the operation of trusts by providing rules for trustees in their investing activities.
Most irrevocable trusts are designed to include the irrevocable trust agreement itself, which is the document that creates the trust, the corpus of the trust, and the named trustee or trustees, and can contain provisions relating to trustee succession in the event of death, incapacity, or resignation of a named trustee, as well as other issues. A court may intervene in a trust pursuant to a judicial proceeding to substitute a new trustee or modify the irrevocable trust agreement so as to carry out the intent of the creator in setting up the trust. In addition to having the power to appoint a trustee, a court also has the power to require a trustee to provide an accounting of the trust or remove a trustee.
When to Get Professional Help
When needed, it’s wise to consult with an estate planning lawyer and a financial professional as you draft an irrevocable trust agreement. A lawyer is able not only to assist in the creation of the document, but can also ensure that the trust will stand up to legal scrutiny and help avoid potential future litigation. In addition, a lawyer can help ensure that the document has been properly executed. While a lawyer may be familiar with how all the elements of an irrevocable trust piece together, a financial professional will have the expertise to identify whether the trust is appropriate and serves your estate planning needs .
If your irrevocable trust has any special or complex elements, or if it covers special or complex estate planning considerations, you should absolutely consult with a lawyer for help with the drafting. These include:
In addition, if you plan to transfer into the trust any assets you’ve received as part of a divorce settlement, a creditor settlement or from the sale of a business interest, you should speak with a lawyer before making those transfers to discuss any marital property considerations and to understand how the transfers will affect your tax liability.