What You Need to Know About Irrevocable Trust Planning

Irrevocable Trust Planning

As perhaps a universal rule, clients desire to retain the flexibility to change their estate plans. Changes may become desirable as family members are born or die, as estates increase or decrease, as desires and objectives change, and as other life events occur. Irrevocable trust planning refers to a subset of estate plans in which clients give up the ability to make changes to their plans down the road.

For example, a client may create a Trust that includes terms that prevent the Trust from being modified. In this case, the client would be generally (although not absolutely, as further discussed below) unable to make changes to the Trust.

Why Create Irrevocable Plans?

There are a few common reasons why a client would want to create an estate plan that they could not later modify.

First, tax reduction. Irrevocable Trusts are used in many ways to achieve reduction of taxes. As a simple example, a client who faces the likelihood of estate taxes may transfer appreciating assets into an irrevocable Trust, thereby removing future appreciation of the assets from the client’s taxable estate. There are many other examples, depending on the client’s circumstances and goals.

Second, asset protection. By transferring assets into an irrevocable Trust, clients may help protect those assets from the reach of future creditors. Note that this area of the law is particularly detailed and great care must be exercised in this type of planning. Under Florida law, efforts to remove assets from the reach of current creditors may be unlawful.

Third, Medicaid eligibility. Clients may use irrevocable Trust in an effort to qualify for Medicaid institutional care (nursing home) benefits. Medicaid rules deny Medicaid benefits to anyone who does not satisfy certain financial requirements. Clients whose income or net worth exceeds Medicaid limitations may create irrevocable Trusts to become eligible for Medicaid. (Note that Medicaid law includes a 5-year ‘lookback’ period, so clients may be disqualified from Medicaid for a period of time if they transfer any assets into Trusts within 5 years of their application for Medicaid.)

There are also other reasons for irrevocable planning, such as special needs planning for a child. All of these goals may be satisfied through proper irrevocable planning.

How Is Irrevocable Planning Accomplished?

Most irrevocable plans include an irrevocable Trust. This type of Trust includes special language expressly stating that the Settlor (the person who creates the Trust) gives up the ability to make changes to the Trust once it is signed. As of the date the Trust is signed, the Trust is generally irrevocable.

Once the Trust is created, the Settlor may transfer real property, bank accounts, and other assets into the Trust. Once transferred, those assets are owned by the Trust.

Assets that are owned by a Trust cannot be removed from the Trust, except to the extent the Trust (and Florida law) permit the removal of the assets. This means that neither the Settlor nor the Trustee (the person who manages the Trust assets) may transfer the assets out of the Trust if those transfers are not permitted.

To emphasize, because the Trust is irrevocable, the Settlor cannot change his mind and take the assets from the Trust. That is one of the principal downsides of an irrevocable Trust. Anyone considering an irrevocable Trust should carefully consider the loss of control that results from an irrevocable Trust.

An irrevocable Trust is treated as a legal entity separate from the Settlor or the Trustee. Maintaining this separation is very important to achieve the purposes of the Trust. Among other things, the Trust must have its own bank accounts, rather than relying on any personal accounts held by the Settlor or the Trustee. In addition, the Trustee will apply for and receive a new Employer Identification Number from the IRS for the Trust.

Sometimes clients want the irrevocable Trust to pay the client a portion of the Trust assets. This is legally permissible, although these payments may frustrate the purposes of the Trust. For example, the Trust may permit the Settlor to receive all income earned on Trust assets, thereby allowing the Settlor to have income from the Trust. This provision, however, may jeopardize the client’s tax reduction, asset protection, Medicaid eligibility, or other goals in establishing the Trust.

Clients must exercise great care in creating irrevocable Trusts. Because the clients are generally prohibited from making changes to the Trust, the Trust must be drafted to take into account life events and other contingencies. As a simple example, the Trust must address what will happen to the Trust assets if a primary Beneficiary of the Trust does not survive to receive the Trust assets.

Can an Irrevocable Trust Be Changed?

As discussed above, the law recognizes various protections given to irrevocable Trusts. As a consequence, the law does not favor changes to the Trusts after they are created.

Nonetheless, there are limited circumstances in which an irrevocable Trust may be modified:

First, the Trust may include provisions allowing modification of the Trust. Although this is the simplest path to modifying the Trust, these types of provisions may cause the Trust to lose the special protections the Trust was designed to achieve.

Second, Florida law permits some modifications to irrevocable Trusts. In some cases, the Trustee and the Beneficiaries may agree to modify the Trust. In other cases, it may be possible to petition a Judge to permit the Trust to be modified.

Nonetheless, it is safest to consider an irrevocable Trust to be ‘locked up’ once it is signed. Certainly it is true that you should not create an irrevocable Trust with the thought that you can always change things later.

A golden rule of estate planning is to plan for today and make changes tomorrow as needed. This is good advice.

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