Q. How do I know if I need a revocable or irrevocable trust?
A. You should consult with a legal professional that handles both kinds of trusts. Provide a clear explanation of your goals and the assets you are planning to use to fund the trust including any life insurance you plan to purchase or stocks you might use to fund the trust. Your attorney should guide you and explain the consequences to you of any proposed options. Your entire financial team – attorney, accountant or tax preparer, and financial advisor – should be involved.
The following is provided solely as general information and to acquaint you with legal terms you may need regarding trusts.
Revocable trusts may be amended or revoked in whole or in part by the donor/settlor, i.e. the person creating and funding the trust. The donor is often the primary beneficiary of the trust. These are also grantor trusts, an IRS term that directs how income is reported for tax purposes, i.e. on the donor’s/grantor’s personal income tax return. The donor(s) or grantor(s) is often the initial trustee(s). These kinds of trust are also referred to as living trusts because they are usually created when the donor is alive as opposed to a testamentary trust created in a will after you die.
Revocable trusts should not be considered a safe vehicle for the protection of the settlor’s assets or to avoid a future Medicaid lien. The main benefit of a revocable trust is to avoid probate, allow for management of the trust estate during any period when the grantor/initial trustee is unable to serve, maintain privacy and to delay discretionary distribution (if so drafted), and possible estate tax savings. Common features include: retention of control to initial trustee(s), flexibility to make changes, no or little maintenance costs once funded, and rapid conclusion of estate administration after the initial beneficiary dies. There are three common types of simple living trusts: a Living Trust for a Single Person, a Joint Living Trust for a Married Couple, and Separate Living Trusts for each spouse of a Married Couple.
Trusts should be irrevocable where asset protection and/or estate planning concerns are of high importance. Irrevocable trusts should be used with caution and only after full explanation of the consequences to the client which include, of course, that they are irrevocable and the Grantor will likely no longer own and cannot get back the assets once placed in the trust. The Trustee will need to obtain a federal tax id number and the Trustee must file fiduciary income tax returns, thus there may be a cost for continuing administration matters for the trust.
An irrevocable trust can be drafted to provide:
- Creditor protection for all beneficiaries except the settlor him or herself. And maybe for the settlor if the trust is set up in a state that allows a domestic asset protection trust or self-settled trusts.
- An effective gift transfer of property to remove the property from the settlor’s estate for estate tax purposes.
- A means of avoiding probate.
- A way to save estate taxes in both the estate of the settlor and the estate of the beneficiary.
- Protection of the estate’s assets from creditors if it is a complete gift, i.e. a gift where the settlor has given up all control over the property with no power to change its disposition, whether for his own benefit or the benefit of another.
A settlor’s retention of a discretionary power to distribute trust income or corpus to himself results in an incomplete gift and the assets are available to the settlor’s creditors. Likewise an incomplete gift occurs when the settlor retains power to add or remove one or more beneficiaries, to “sprinkle” income or principal among current beneficiaries or to distribute or accumulate income with respect to a current beneficiary, thereby affecting the amount available to a remainder beneficiary. A settlor may be able to influence an irrevocable trustee’s decisions, but never legally control the trustee.
The kinds of irrevocable trusts you might hear about are irrevocable life insurance trusts, Medicaid qualifying trusts for disabled beneficiaries, an ABLE account trust, an Income-Only trust, a Medicaid Income Trust, a charitable remainder trust and a Johnny Michael Spann Patriot Trust used exclusively for the survivors of military and government personnel whose death was due to an act of terrorism.
The IRS has warned tax payers about abusive trust arrangements that seek to shift the taxpayers’ income to another entity for income tax purposes or to make one’s personal living expenses tax deductible. Off-shore asset protection trusts are legal because they are considered grantor trusts for federal income tax purposes. Certain VA and Medicaid avoidance trusts pose significant risks to the settlors and should only be undertaken with the advice of a lawyer well versed in this area of the law.
There is a lot to know. Select someone knowledgeable to help you.
Disclaimer: Information contained in this column is meant to be of general information on frequently asked questions concerning disability, elder law, estate planning and probate law, and does not contain specific legal advice to a client. No attorney-client relationship is created by reading this column. 1/2019