Irrevocable Trust

An irrevocable trust is a separate legal entity, with its own tax identification number, set up by the trust creator (Settlor) to hold assets. Once assets are transferred to an Irrevocable trust, they cannot be taken back, and the terms of the Irrevocable trust generally cannot be changed after the document is signed.

Assets that are transferred to the trust are considered ‘gifts’ to the trust. That means that a Gift Tax Return (IRS Form 709) may be required to report the gift to the IRS. The biggest advantage to an Irrevocable Trust is that they provide a way to remove assets from a person’s taxable estate, yet the person can designate where those funds will go upon his or her death or the occurrence of some other event. Most people who consider Irrevocable Trusts are in a situation where substantial estate taxes would be due upon death if assets were not removed from the estate.

A few of the more common types of Irrevocable Trusts are summarized below.

Irrevocable Life Insurance Trusts (ILIT). An ILIT is an easy and efficient way to remove assets from the taxable estate while having little or no gift tax consequences. Also, a great way to get a substantial tax-free distribution to children upon death. People often use these in conjunction with a charitable giving strategy. That way, they feel they are not ‘short-changing’ the children by giving a generous gift to charity.

• Trust is created, trustee purchases a life insurance policy on the trust creator’s (Settlor) life.
• Settlor usually makes annual gift ($15,000/$30,000 if married per trust beneficiary) to the trust to fund premium payments, but other methods of premium payment are also used.
• Beneficiaries must be notified when contribution is made of right to withdraw funds (“Crummey” notice).
• Eventually policy will be ‘paid up’ and trust just waits for payout at death.
• At death, Life insurance proceeds pass to beneficiaries free of estate and income tax.

Grantor Retained Annuity Trust (GRAT). These are used when significant assets need to be removed from a taxable estate, and there is a desire to minimize the gift tax impact.

• Assets are transferred to an irrevocable trust.
• Grantor (Settlor) retains income payments for a period of years – this reduces the value of the gift.
• If grantor ‘outlives’ term, assets pass to beneficiaries or remain in trust for a period of years or until Grantor’s death.
• If grantor dies during the time he or she is still receiving the income payments, the transferred assets remain as part of the grantor’s estate. So it’s important that the Grantor be likely to live longer than the ‘retained interest’ period, or the strategy is ineffective.
• Transferring the assets will minimize estate tax, but beware of capital gains!
• Transferred assets take the same basis the grantor had, so upon sale, there may be significant capital gains.

Charitable Remainder Trust (CRT). A CRT is a great strategy for those who want to remove assets from their estate, provide for charity, and retain an income stream for lifetime.

• Assets are transferred to an Irrevocable Trust. People often transfer low-basis assets to these trusts, due to capital gain treatment if the asset is sold within the charitable trust.
• Tax deduction is taken in year of funding (or spread over 5 years) for present value of ‘gift’ amount.
• Income is paid to donor for a term of years or for life or over joint life.
• At grantor’s death, the balance goes to charity.
• May be used in conjunction with an ILIT; the income stream from the Charitable Remainder Trust could even pay the life insurance premiums, and the children get a wonderful tax-free gift upon death.

Revocable Trust

At its most basic level, a Revocable Trust is an agreement that directs the management of the assets owned by the trust during lifetime, in the event of disability, and upon death. During lifetime, the trust creator (we will say ‘you’ or ‘your’ here) will transfer all assets into the name of the revocable trust, or name the trust as beneficiary on most or all accounts. The trust is almost ‘invisible’ during lifetime; the income is still reported and taxed to your social security number, just as before. You may buy and sell assets freely and spend as much money as you want, just as before.

However, a Revocable Trust has some very significant advantages, particularly at disability and after death:

Disability. easy transition. The successor trustee you have appointed, simply takes over to manage the assets for your benefit during any period of disability.

Estate Tax Planning. While assets in a revocable trust are considered part of the ‘gross estate’ of the trust creator for estate tax purposes, a properly drafted trust, will minimize estate tax for married couples by fully utilizing exemption amounts of both spouses by using credit shelter or disclaimer trust provisions.

The idea is to fully utilize the estate tax exemption amount for both spouses, by having some assets pass to a Trust upon the first death, rather than having all the assets pass to the surviving spouse, and being left with only one exemption amount to use.

Example: Joe and Mary have $6 million between them, and each owns $3 million in his/her respective Revocable Trust. Their Trust provisions allow for the funding of a Disclaimer Trust if the surviving spouse wishes to utilize it. Let’s say Joe dies. Under the terms of his Trust, his $3 million will pass to Mary. But Mary may not want to take all of it because then she will have $6 million in her trust, and everything over $3 million (in 2020) will be subject to Minnesota estate tax.

Mary may disclaim the $3 million so that it passes to a Disclaimer Trust. She must do this within 9 months of Joe’s death, she can’t have accepted any of the assets she is disclaiming, and the disclaimer must be in writing. Once the assets are properly disclaimed, Mary will receive all the income from that disclaimer trust, and she may access the principal if she needs it for her health, education, support or maintenance. Upon Mary’s death, the assets in the disclaimer trust and the assets in her trust pass down to the children per the terms of the trusts.

Avoid Probate. This is an important reason people use Revocable Trusts. Probate is avoided because at death, there are no assets in the decedent’s name, so there is nothing to probate. All assets are owned by the trust, and simply pass according to the trust terms. This has several advantages:

• Cost Savings – Typically saves thousands of dollars, and a lot of headache for the family.
• Privacy – no publication of assets, and no court supervision of the asset distribution (note: sometimes it is desirable to have court supervision, so probate might be the right choice for some people).
• Asset Control – Assets go to whom you wish, when you want them to pass. For example, you might say you want 1/3 of the assets to pass to the children upon death, ½ of what remains 5 years later, and the balance 5 years after that. Or you may select ages for distribution, such as 25, 30, and 35. There are many options here, depending on your assets and your wishes. Trusts may address specific concerns.

Consult with your Estate Planning attorney for more complete information on these and other strategies. This information is not intended to be complete, so do not make decisions based on this article without having your attorney evaluate your specific situation.