IRREVOCABLE TRUST PRIMER

Here are some general types of trusts that are usually confined to those requiring a bolder implementation of estate planning, either because of certain business activities in which they are participating, and/or the degree of wealth they may wish to protect from certain potential hazards.

Irrevocable trusts cannot be terminated after they are finalized. This sets them apart from revocable trusts which can be terminated, at least until they become irrevocable at the death of the trust maker (the grantor). When talking about trusts, the term “living” means that the trust goes into effect during the grantor’s life.   So, an irrevocable living trust is a trust that 1) goes into effect during the grantor’s life and 2) cannot be revoked. An exception to these general rules is a “testamentary” trust, which is made during a grantor’s life, but does not go into effect until the grantor’s death.

  1. General Trust Terminology  

These terms can get confusing, so here is a breakdown:

Term Definition
Revocable trust A trust that can be revoked.
Revocable living trust A trust that can be revoked and that takes effect during the life of the grantor. Becomes irrevocable at the death of the grantor. Usually made to avoid probate.
Irrevocable trust A trust that cannot be revoked.
Irrevocable living trust A trust that cannot be revoked and that takes effect during the life of the grantor.  Usually made to transfer wealth, protect assets, or reduce taxes.
Testamentary trust A trust created during the life of the grantor, but that takes effect at the grantor’s death.  Usually made as part of a will. For example, a child’s trust is made to name a trustee for property left to a minor.
  1. Types of Irrevocable Trusts

There are dozens and dozens of types of irrevocable trusts made for different purposes.   The two most common reasons to make an irrevocable trust are 1) to reduce taxes, and 2) to protect property.

  1. Irrevocable Trusts to Reduce Taxes

Grantors most often use irrevocable trusts to avoid or reduce taxes.  Here are examples:

  • Bypass Trusts – A trust used by spouses to reduce estate taxes when the second spouse dies. When the first spouse dies, the bulk of his or her property goes into the trust. The surviving spouse can use trust property (and income from trust property), but he or she never owns it. So, when the “surviving” spouse dies, that the first spouse’s property is not included in his or her estate.
  • QTIP Trusts – A trust used by couples to postpone the payment of estate taxes until the second spouse dies.
  • QDOT Trusts – Like QTIP trusts, but used when one spouse is a noncitizen.
  • Charitable Trusts – A trust designed to reduce income and estate taxes through gifts to charity.   Three types of charitable trusts are:
    • charitable remainder trusts – You put property in a trust, name a charity to be the final beneficiary, and then name someone else to receive income from the trust for a set amount of time.
    • charitable lead trusts — You put property in a trust, name a charity to receive income from the trust for a set amount of time, and then name someone else as a final beneficiary.
    • pooled income trust – You pool your money with other trust makers and receive trust income for a set time. For pooled charitable trusts, a charity is the trustee and the final beneficiary.
  • Generation-Skipping Trusts – These trusts are designed to reduce estate taxes for wealthy families.   The final beneficiary is a grandchild or group of grandchildren. The child is usually an income beneficiary, but never owns the property, so that the trust property is not subject to estate tax when the child dies. This type of trust is subject to a generation skipping transfer tax.
  • Life Insurance Trusts – These trusts reduce estate taxes by removing the proceeds of life insurance from a taxable estate.   Instead, the trust owns the insurance policy. The beneficiary of the policy can be anyone, but the trustee must be someone other than the previous owner of the policy.   The grantor cannot have any control over the policy once the trust is made, and the trust must exist for at least three years before the grantor’s death.
  • Grantor-Retained Interest Trusts (GRATs, GRUTs, GRITs, and QPRTs) – These trusts also reduce estate taxes by removing property from a taxable estate.   The trust maker puts property into the irrevocable trust and names final beneficiaries, but retains some interest in the trust for a set amount of time. That interest might be a fixed annuity from the trust (GRAT), a variable annuity (GRUT), trust income (GRIT), or the right to live in the trust property (QPRT). When that set time period is over, the final beneficiaries own the property outright, and the IRS will value the gift at the time of the creation of the trust. The grantor must outlive the terms of the trust, or no savings will be created. 
  1. Irrevocable Trusts for Protecting Property

Irrevocable trusts can also be used to meet other goals, such as to protect assets from being squandered or to protect the assets of a person with a disability.

  • Spendthrift Trusts— Spendthrift trusts allow you to protect (and control) gifts that you give to those who may not be able to manage the money themselves.   You put property into a trust, and the trustee (which can be you) doles out money to the beneficiary according to the terms of the trust.   The beneficiary cannot access trust property on his or her own, so it is protected from the beneficiary’s creditors, at least until payments are made directly to the beneficiary.
  • Special needs trusts —A special needs trust provides financial support for a person with special needs, without affecting his or her qualifications for government benefits. Property is put into a trust for the benefit of a person with special needs, often by a parent or other relative. The terms of the trust allow the trustee to use trust funds to buy certain things for the beneficiary, but because the beneficiary never owns trust property, it is not considered to be an asset when he or she applies for government benefits.
  • Asset Protection Trusts–The only way the trust assets could be protected from creditors of the creator of the trust (hereafter “Settlor”), was for the Settlor to give up complete control of and benefit from the trust and the trust assets. If the Settlor retained the power to serve as trustee of the trust, amend the trust, receive distributions from the trust, or to derive any benefit from the trust, creditors of the Settlor could attach assets in the trust to satisfy debts of the Settlor.

Traditionally asset protection is afforded to beneficiaries of a trust through inclusion of a “spendthrift provision” which specifically prohibits creditors from making claims against a beneficiary’s interest in the trust and prevents the beneficiaries from transferring or pledging their interests in the trust.

However, the creditor protection is generally unavailable to the creator of the trust. If an individual establishes a trust of which he or she is also a beneficiary, a “self-settled trust”, the trust is generally ignored for purposes of the creator/beneficiary’s debts and liabilities.

An asset protection trust is a trust that protects the trust assets from creditors and liabilities of the beneficiaries. That is, as long as the assets are in the trust they are not the personal property of the beneficiaries and therefore, not subject to the beneficiary’s debts.

Under Nevada law for example, if a creditor was a creditor of the Settlor    at the time the Settlor made the transfer to a NAPT, the creditor must commence an action to challenge the transfer within the later of (a) two years after the transfer, or (b) six months after the creditor discovers or reasonably should have discovered the transfer.

A creditor who was not a creditor of the Settlor at the time the Settlor made the transfer to a NAPT must commence an action to challenge the transfer within two years of the transfer. The act that starts the statute of limitations running is the transfer of assets. Therefore, each time assets are transferred to the NAPT, a new transfer has occurred and the statute will begin to run on a claim against that asset.

Finally, even if the statute of limitations does not bar the claim, the creditor is required to show that the transfer was a “fraudulent conveyance.” A fraudulent conveyance is a transfer of an asset with the intent to hinder, delay or defraud the creditor. The intent to hinder, delay or defraud creditors can be inferred if the transfer renders the transferor insolvent. Therefore, the Settlor should not transfer all of his asset into a NAPT.

What makes the NAPT unique is that the Settlor can also be a beneficiary of the trust. The only limitation is that the trustee cannot be required to make distributions to the Settlor. While this can be a limitation to the Settlor, it is outweighed by the benefits of the powers and controls the Settlor can retain and still have creditor protection from the trust.

WFB LEGAL CONSULTING, Inc.–Lawyer for Business–A BEST ASSET PROTECTION Services Group

WHAT ARE THE REAL ADVANTAGES OF A LIVING TRUST?

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Living Trusts

Over the last two decades, the popularity of Living Trusts has skyrocketed. No longer are a tool just for the rich, Living Trusts one of the most common estate planning tools in use today. In fact, today’s estate planning is not just about death and taxes, but includes protection of one’s assets from the potential claims of creditors as well as personal income tax planning. This legal arrangement, usually drafted by an estate attorney, creates a separate entity called a Living Trust. A Living Trust is called that simply because it is created while you’re alive (as opposed to a “testamentary” trust created after death).

The Parties Involved The Living Trust document itself names three different parties. The individual (or couple) that establishes the Trust is named the Grantor (also referred to as the Trustor). The Trustee is the person named by the Trust as the controller of the Trust’s assets (and in many cases, the Trustees are the same people as the Grantors). On the receiving end, the Beneficiaries are the heirs that will benefit from the Trust once the Grantor’s have passed away.

Who Needs A Living Trust? Almost anyone with an estate of $100,000 or more can benefit from having a living trust. Estates of $100,000 or more are often subjected to probate in their state of residence, which can cost anywhere from 2%-4% of the estate’s value in court and legal fees. The living trust also is useful for individuals subject to estate taxes. Through a living trust, a couple is able to maximize their Unified Credit to its fullest. It even accomplishes protection for individuals wanting to avoid conservatorship. Advanced living trusts can be structured for complicated family situations. Re-married spouses, with children from a previous marriage, can use an advanced revocable trust to ensure kids receive their proper inheritance.

Avoiding Probate Living Trusts avoid probate, since they are completely private. Because a trust is recognized as a separate legal entity, distributions can be made by a Trustee to named beneficiaries without any involvement from the courts. The courts maintain no control over the Trust’s assets, and do not tie up the assets in a lengthy (and costly) probate process. The Trustee simply distributes assets to named heirs, but only if those assets have actually been placed inside the Trust.

Funding Your Living Trust Once established, almost anything can be placed in a trust: savings accounts, stocks, bonds, real estate, life insurance, and personal property. In “funding” the trust, you simply change the name or title on your assets to the name of your Trust. Many people worry about losing control of assets; however, that is not the case within a carefully-constructed Living Trust.

Always There for You Because the Trust is essentially controlled by one individual (the Trustee), that person can carry out your wishes when you’re not able to. For instance, if you have children from a previous marriage and wish to leave them an inheritance, specific instructions to the Trustee will ensure that they receive what you had requested. If you’re institutionalized or unable to care for yourself anymore, the Trust can still function and make distributions as needed. The Trustee has a fiduciary responsibility to see that your requests are fulfilled exactly. He or she can even provide care and protection for disabled relatives or handicapped children in accordance with your wishes.

Reducing Estate Taxes The Living Trust also minimizes estate taxes by fully utilizing every individual’s Unified Credit. The Estate Tax Credit, as mandated by Congress, currently shelters up to $5.43 million from estate taxes. With only a will in place, a married couple will receive a single $5.43 million exemption. However, if a Living Trust with “A-B Provisions” is in place and one spouse dies, the Living Trust separates into two separate trusts (commonly referred to as an A-B Trust).

In an A-B Trust, each of the two separate trusts receives its own $5.43 million exemption, meaning a total of $10.86 million is sheltered from estate taxes. Any amounts over that $10.86 million will be subject to estate taxes, with rates climbing as high as 46%. Living Trusts are easy to start-up and require little on-going maintenance. They afford an extra measure of protection against loss of control, and ensure that your assets remain out of the public record even after your death. However, they do not provide protection against creditors or divorce, and do not reduce estate taxes for estates over $5.43 million in value ($10.86 million if married). Each family’s situation is different. Some will benefit from a living trust, while others may not. If you are married or have assets over $100,000, you owe it to your family to investigate the best means to preserve your hard-earned wealth. And for estates over $5.43 million, you may want to combine a living trust with another advanced estate planning technique.