All about Irrevocable Trusts - a step-by-step reference quide
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Trust agreement defined - What is it?
- The purpose of a Trust is to create an "Artificial Legal Person" to protect, hold, and manage your private wealth for the benefit of your heirs.
- As in any contract, someone must initiate the contract (Grantor or Trustee). So the Grantor Trust is simply someone who has initiated the Trust. Read below for what is a Non-Grantor Trust.
- The contract (trust agreement) must specify the who, what, where, when, why, and other conditions.
- Finally, the contract is for the benefit of someone or something. In other words, the beneficiaries could be the wife, children, grandchildren, church, other charitable organizations, etc.
How does a Grantor of a Trust relate to the Trust Contract?
The concept of a trust was first used in Anglo Saxon times and is a contractual arrangement whereby property is transferred from one person (The Grantor) to another person or corporate body (The Trustee) to hold the property for the benefit of a specified list or class of persons (The Beneficiaries).
Although a trust can be created solely by verbal agreement it is normal for a written document to be prepared which evidences the creation of the trust (the Trust Deed) which sets out the terms and conditions upon which the trust assets are held by the Trustees and outlines the rights of the Beneficiaries. In essence, a Trust is not dissimilar to a will except that assets are transferred to Trustees during lifetime rather than those assets being transferred to executors on death. The Trust Deed is analogous to the deed of will.
The three elements to a Trust Document:
- Grantor (also called Settlor)
The Grantor of a Trust
The Grantor in a Trust is the person with the bucks. In other words, the Grantor of a Trust contract is the owner of the asset(s) which could be any asset from personal residential real estate to stock accounts to business or partnership assets and anything else of monetary value. The Grantor's motivation is to get asset(s) out of his name for either some or all of the following:
- Asset protection and wealth preservation
- Reduce potential frivolous lawsuits
- Elimination of the "probate jail process" (see definition, below)
- Elimination of estate taxes
- To gain some tax benefit or some other tax deferral benefit
If the Grantor initiates the Trust (contract), it's called a Grantor Trust; otherwise it's called a Non-Grantor Trust. To us, it's just legal garbage so lawyers can charge you more.
If the Grantor wants to retain certain control over his asset(s), it's called a Revocable Trust; otherwise, it's an Irrevocable Trust.
Revocable Trusts and Irrevocable Trusts have significant asset protection and tax differences. One can think of a Revocable Trust like the kid next door that brings the ball to play basketball with the other kids. Everything is fine, as long as he makes the rules, and he makes the rules as he goes along. If you don't agree, he takes the ball and goes home. The ball game is over. In the Revocable Trust, he has control and hence the name "Revocable."
Grantor retains control in Living Revocable Trusts
Since the Grantor retains control in the Living Revocable Trust, it can destroy your estate in the event of a lawsuit, serious illness or elderly care. The Living Revocable Trust is also known as the Living Trust. From the Grantor's perspective, the sole purpose of the Living Revocable Trust is to eliminate the probate process.
- Assets in a trust, avoids probate
- Assets NOT in a trust goes to probate with or without a will
However, the Grantor may or may not realize the Living Revocable Trust is outright dangerous for asset protection, wealth preservation, and estate tax elimination. The Living Trust is obsolete for assets greater than $675,000. With the Living Trust the Grantor (i.e. owner of the assets) retains significant power over his wealth and will not insulate assets from the lawsuit explosion. There's absolutely no tax benefit, no asset protection and no wealth preservation benefits with the Living Revocable Trust to the Grantor. We do not recommend the Living Revocable Trust for the Grantor.
Actually, we think the Living Revocable Trust is a sham perpetrated on the Grantor by shameless 'professionals' out to extract more than just one fee. Every time the Grantor needs or wishes to change the Trust Deed, he needs to speak with his lawyer. The lawyer just garnered another fee. So we recommend to customers, "Don't just walk. Run!"
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Revocable Trusts vs. Irrevocable Trusts
Here we examine the differences of revocable trusts vs irrevocable trusts. If you reposition (transfer) your assets through the use of an IRREVOCABLE TRUST, you will no longer own them. If you don't own assets, no one will want to sue you; no one will want to track your spending habits; no one will call you to interrupt your dinner. You don't have to go offshore. US Laws, US courts will defend and support your asset protection system. These laws have been defined by numerous court cases, over and over, right up to the Supreme Court. You must however, give-up control over your assets to a true independent trustee.
Legitimate repositioning (transfer) of assets from you to an irrevocable trust is perfectly legal. The fact is, if your assets are owned by a subchapter S. Corporation or a Limited Liability Company and in turn the shares of the Sub S or membership units of the LLC are owned by an irrevocable trust, it's the fortress of US Asset Protection. The ultimate asset protection device is the use of an offshore asset protection trust.
The following financial grid explains the major differences between revocable vs. irrevocable trusts:
||REVOCABLE TRUST (REVOCABLE LIVING TRUST)
||ABSOLUTELY NO Asset Protection. NONE. The Grantor, The Trustee, and the Beneficiary are generally the same person. The Grantor did not give-up control of the asset(s).
||YES. The Grantor no longer owns the assets. Assets have been transferred to the INDEPENDENT Trustee who has a fiduciary duty to manage the assets for the benefit of all beneficiaries, which may include the Grantor.|
|Eliminate Estate Taxes
||YES. Assets are not subject to the Estate Tax. The deceased did not "own" the assets or have assets in his possession at the time of his death.|
|Defer / Reduce Capital Gains Taxes
||YES. Assets transferred to the Trust can be structured without capital gains taxes.|
|Defer / Reduce Income Taxes
||YES, if combined with international structure.|
|Form 1040 income tax benefits
||YES. You have done nothing. You still "own" the assets. All Income and Expenses flow-through to the Grantor's form 1040.
||YES. If this is a Grantor-Type Trust, for income tax purposes, all income and expenses flow-through to the Grantor's form 1040.|
||The Revocable Trust is designed to eliminate probate. DOES NOT eliminate estate taxes; ABSOLUTELY NO asset protection. The Revocable Trust is nothing more than an extension of your will.
||For asset protection purposes the trust is irrevocable. Under certain conditions, the trust can be designed to be a pass-trough trust for income taxes.|
The Revocable Trust (Revocable Living Trust):
What's wrong with a revocable trust (revocable living trust) is that the owner of the assets (the Grantor) retains too much power over the disposition of the trust assets. This direct control nullifies any defenses against potential frivolous lawsuits. His deemed control is equivalent to ownership, and if you still own the asset you are liable to lose them in a lawsuit. And if you own the asset you will incur an estate tax.
The laws of most states permit the formation of a variety of revocable trust instruments (AB "Family" Trust, QTIP Trust, Crummey Trust, Retained Interest Trusts such as GRITS, GRATs, GRUTs, and QPRT), whereby the trust creator (Grantor) contributes assets for the benefit of others to be managed by a Trustee. While it is also possible for the creator to be either the Trustee or a Beneficiary of the trust he or she has created, such dual capacities will usually destroy the trust's ability to shelter its assets from creditors of the Grantor. When a Grantor reserves an unqualified power of revocation, he or she is deemed the absolute owner of the trust property, as far as the rights of creditors are concerned. This is true even if a Grantor of a trust does not retain a beneficial interest in the trust, but simply reserves the power to revoke it.
The Irrevocable Trust:
Unlike a revocable trust (revocable living trust), assets transferred to an "irrevocable" trust cannot be changed or dissolved by the Grantor once it has been created. The Grantor no longer owns the assets. An independent Trustee is your best defense. With an independent trustee, you generally can't remove assets, change beneficiaries, or rewrite any of the terms of the trust. An irrevocable trust is a valuable estate-planning tool. First, you transfer assets into the trust--assets you don't mind losing control over. You may have to pay gift taxes on the value in excess of $1million of the property transferred at the time of transfer or you may be able to set-up a mock sale by using a device known as a private annuity to avoid capital gains taxes.
With an irrevocable trust, all of the property in the trust, plus all future appreciation on the property, is out of your taxable estate. That means your ultimate estate tax liability may be less, resulting in a more tax efficient way to transfer your accumulated wealth to your beneficiaries. Property transferred to your beneficiaries through an irrevocable trust will also avoid probate. As a bonus, property in an irrevocable trust may be protected from your creditors. Of late this irrevocable trust device is being utilized by many planners for avoiding the Medicare nursing home spend-down provisions whereby if the elderly has to enter a nursing home he must first spend all his money until he does not have any money left.
Use the Irrevocable Trust as the owner of the LLC. The Manager of the LLC can also be the Trustee of the Trust. Just make sure that the Settlor (Grantor) and the Beneficiaries are different people than the Trustee and each other. In other words, there needs to be three, distinct parties to the Trust. A simple way is to have a friend act as the Settlor, you as the Trustee, and your kids (or another entity) as the Beneficiaries.
A quick word about the independent trustee: most people don't like to give up control over their assets because of their perceived notion that giving up control is equivalent to leaving the wolf in charge of the henhouse. The law imposes strict obligations and rules on trustees including a duty to account for any benefits the trustee may have gained directly or indirectly from a trust. This goes beyond fraudulent abuse of position by a trustee.
The courts regard a trust as creating a special relationship which places serious and onerous obligations on the trustees. The law regards the special "Fiduciary" relationship of a trust as imposing stringent duties and liabilities on the person in whom confidence is placed - the trustees - in order to prevent possible abuse of that confidence. A trustee is therefore subject to the following rules:
- No private advantage -
A trustee is not permitted to use or deal with trust property for direct or indirect private advantages. If necessary the court will hold him personally liable to account for any profits made in breach of this obligation.
- Best interests of beneficiaries -
Trustees must exercise all their powers in the best interests of the beneficiaries of the trust.
- Act prudently- -
Whether or not a trustee is remunerated he must act prudently in the management of trust property and will be liable for breach of trust if, by failing to exercise proper care, the trust fund suffers loss. In the case of a professional the standard of care which the law imposes is higher. Failure to exercise the requisite level of care will constitute a breach of trust for which the trustee will be liable to compensate the beneficiaries. This duty can extend to supervising the activities of a company in which the trustees hold a controlling interest.
Legal safeguard of an irrevocable trust: In cases of substantial assets, you may add one other safety measure, "the Trust Protector." The trust protector's sole function is to hire and fire trustees, at will and without explanation. Be sure to use limits on how much a trustee can be authorized to spend without a second signature.
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What Are the Advantages of an Irrevocable Trust?
An irrevocable trust is a trust that cannot be changed or altered after it is set up. With an irrevocable trust, a person gives up ownership of all his assets and transfers the ownership to a trust that is managed by a trustee. The person still has use of the assets, but no longer owns or controls them. In most cases, a person transfers ownership of the house, cars, bank accounts, brokerage accounts and other assets to the trust. There are a few benefits to an irrevocable trust.
- The assets are protected from lawsuits. The grantor (the person setting up the trust) does not own any property or have any assets so there is no reason for anyone to sue him.
No Estate Taxes:
- Since the deceased did not own any assets, there is nothing to be taxed upon his death.
- After a person dies, her estate goes into probate as the court decides who the heirs are and who gets what assets. This process can take a long time even if the deceased left a will. An irrevocable trust avoids all this.
Easy Charity Donations:
- With an irrevocable trust, it is easier to give property to charity. There is also no tax on this property because it comes from an irrevocable trust.
Peace of Mind:
- With an irrevocable trust, you know your assets cannot be seized because of a lawsuit, and your know your family is taken care of as the beneficiaries. Also, should the grantor become incapacitated, any financial issues have already been decided by him through the trust.
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What Are the Disadvantages of an Irrevocable Trust?
An irrevocable trust, also called an income trust, is a legal entity created to own and control assets on behalf of third parties. The assets of the trust come from a grantor, sometimes called a settlor, and are managed by a trustee. Irrevocable trusts do not necessarily produce a distinct tax advantage for a grantor, and can be far more complex than revocable trusts.
As with any trust, the grantor (or settlor) of an irrevocable trust gives certain assets over to a trustee, who manages them for a beneficiary. The unique feature of an irrevocable trust is that the grantor fully surrenders ownership of the assets and has them re-titled in either the name of the trust or the trustee. This feature distinguishes irrevocable trusts from living trusts and others, where the grantor typically retains ownership. This loss of ownership (and the costs associated) is one of the disadvantages of an irrevocable trust, at least for a grantor seeking to retain control during their lifetime.
- This distinction of ownership is crucial to the IRS for income tax purpose. Income generated by estates held in revocable trust (called grantor trusts) flows through to the grantor and is taxed at their individual rate. Not so for an irrevocable trust, which is taxed as a separate entity at a brisk 35 percent on taxable income above $10,000.
- The high tax rate on income associated with an irrevocable trust leads trustees to distribute all income (or at least enough to get below the tax threshold) to beneficiaries annually, where it is taxed at the individual rate of the beneficiary. If the grantor is a beneficiary, they receive no particular tax benefit of the assets' income unless their share of the income is not enough to lift them to a higher tax bracket, but the total income would have if they had remained the sole owner. This feature of irrevocable trusts is the reason they usually contain high income generating assets and are often called income trusts.
- Another disadvantage of an irrevocable trust is that, because it is a separate taxpaying entity, it must file its own annual tax returns. This is not the case will all other forms of trusts, which are considered grantor trusts by the IRS, and are taxed through the grantor or beneficiaries. This can significantly increase the cost of maintaining the trust in terms of time, effort and accounting fees.
- Because the grantor surrenders title to assets transferred to an irrevocable trust, and the trust is considered a separate tax entity, the trust property cannot just be given over for free. When a grantor transfers property to an irrevocable trust, they must count the full market value of the property towards their gift exclusion, which is $11,000 per beneficiary annually. If the value of the property exceeds this exclusion, the grantor is subject to a gift tax on the value in excess of the allowance. The grantor must also give the beneficiary the right to withdraw the asset from the trust in order for it to count as a gift, though the beneficiary generally does not do so.
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What Are the Irrevocable Trust Benefits?
Estate planning is an important concern for many people. Because doing it right means navigating complex IRS rules, most find it very beneficial to hire a professional estate planner or attorney when creating an irrevocable trust. Though an irrevocable trust is more complicated and more expensive to create than a revocable trust, it offers unique properties and advantages.
- An irrevocable trust is one in which the creator of the trust (settlor) cannot revoke or alter the terms of the trust. Usually, the trust is designed so the settlor surrenders all claim of ownership in the trust property. But depending on the terms of the trust, it might or might not be treated as a grantor trust by the IRS, which affects whether income in the trust is taxed through the creator of the trust or as a separate entity. Irrevocable trusts are funded with after-tax donations, usually linked to a specific beneficiary and deducted under the gift tax exclusion.
- The most obvious benefit of an irrevocable trust is that it shields assets from probate. A common use of this benefit is through an irrevocable life insurance trust (ILIT), in which the life insurance policy of the settlor is irrevocably placed in a trust for the benefit of named beneficiaries without recourse to probate or creditors. Life insurance is a perfect asset for an irrevocable trust because it is of little use to the settlor during their life.
Eliminate Estate Taxes:
- The irrevocable trust can shield assets from the estate tax if it meets certain conditions contained in §§2306 to 2308 of the Internal Revenue Code (IRC). These relate to the extent to which the settlor can control the assets in the irrevocable trust. If the conditions are met, the assets of the trust do not count towards the estate of the deceased settlor and therefore do not contribute to estate tax liability, if any.
Defer/Reduce Capital Gains Tax:
- The assets of an irrevocable trust can, however, be included in the gross estate of a deceased settlor if the trust does not meet the requirements of the IRC mentioned above. If the assets pass to a beneficiary upon the settlor's death, they can be received with a stepped up, or fresh start, tax basis, which means the beneficiary receives them without any capital gains tax liability. If a carryover basis is maintained, the trust can be structured so the tax is deferred until the sale by the beneficiary.
Income Tax Considerations:
- In most cases, an irrevocable trust is designed to be taxed as a separate entity. But, because the tax rate on such trusts is higher than most individual tax rates, any income produced is generally distributed to beneficiaries annually and written off by the trust. This can help reduce overall income tax liability if the income is sufficient to raise the settlor or any single beneficiary into a higher tax bracket. But, by making the trust intentionally defective for income tax purposes (by giving the settlor certain controls over the trust) the income of the trust will be taxable at the settlor's individual rate. A skilled lawyer can devise a trust that avoids income tax in this way while still avoiding probate and estate tax.
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What's a Trust Protector?
In offshore Foreign Asset Protection Trusts the role of "Asset Protector" is a standard. Offshore countries have extensive networks of Trust Companies specifically designed to accommodate the implementation of Trust Agreements with ready Trustees. The election to have a Trust Protector, who is usually a United States Person, is a normal offshore business transaction.
Although in Foreign Asset Protection Systems the role of the Trust Protector is a standard, domestically in the United States, only a few states have a legally recognized the dual existence of Trustee and Trust Protector. Those states are Alaska, Delaware, Idaho, South Dakota, and Wyoming.
The power of the Trust Protector is derived from the Trust Contract. The Agreement sets forth the dual function of the Trustee and the Trust Protector. While the Trustee can be a bank or trust company, or other financial institutions, the Trust Protector is usually a person close to the family, a CPA, accountant, or lawyer who is already the family consigliore.
The Trust Protector's Powers
The Trust Protector's powers can take any form, limited only by the wishes of the Grantor(s) and their imagination. Generally, the powers granted the Trust Protector are:
- Ability to remove or replace the Trustee. Often this is the only power granted to the Trust Protector. In cases where the Trustee is a corporate body (bank, trust company, insurance company, or professional trustee) if the Trustee is unresponsive or not performing to the Trust Agreement for the benefit of all Beneficiaries, or changes in management, or investment choices, the Trust Protector can fire and replace the Trustee, at will, without explanation to the current Trustee.
- Ability to change the Trust's situs to take advantage of law changes or necessary steps to act in the best interest of beneficiaries if they move from low tax states to high tax states, i.e. from California or New York (high tax states) to New Hampshire, or Nevada (low tax states) or changes in laws occurring long after the initial implementation of the Trust Agreement.
- Ability to resolve deadlocks between co-trustees or in squabbling between the Trustee and/or Beneficiaries.
- Ability to control spending over a certain amount. This level of control is significant if disbursements of the Trust are in excess of pre-arranged amounts requiring two signatures of the Trustee and the Trust Protector i.e. in excess of $10,000.
- Ability to veto distributions to Beneficiaries. Before distributions are to occur the Trust Protector may want to investigate the financial stability of the Beneficiaries. For example, if the beneficiary is being sued, The Trust Protector may withhold distributions, or the Beneficiary is undergoing divorce proceedings, or the Beneficiary may be too young, is under duress, mentally incompetent, unable to manage, or otherwise unavailable. The Trust Protector can override/veto the Trustee and withhold distributions temporarily or permanently make other arrangements such as buy the assets necessary for the benefit of the Beneficiary (buy a house, a car, sign a rental agreement, but have the Trust own the assets, make loans or make other provisions.
- Ability to veto investment decisions. This checking and balancing of investment decisions are based on the Trust Protector's experience, prudence, and the Trust Agreement guidelines in protecting the assets for the Beneficiaries.
- Ability to sue and defend lawsuits against the Trust assets. The fiduciary duty of the Trustee and The Trust Protector as to save the assets of the Trust, at any cost, for the benefit of all classes of Beneficiaries.
- Ability to terminate the Trust. If in the opinion of the Trust Protector there are insufficient funds or the cost of administration is greater than available cost/benefit, the Trust Protector may terminate the Trust, as for example, if all beneficiaries have received their distributions based on age (over the age of 21) and there's one minor beneficiary currently 10 years old, and there aren't enough assets to administer the Trust for the next 11 years, the Trust Protector has the power to make the final distribution and terminate the Trust.
Trust Protector's Role
The Trust Protector's role is created by the Trust Agreement to add an additional layer of protection and is usually a person most familiar with the Grantor's long-term financial and personal goals. A Trust Protector usually is the balance of power between the Trust Agreement, the Trustee, The Grantor, and the Beneficiaries.
Neither the Trustee or the Trust Protector should be a family member, nor anyone related to the family by blood or marriage. Both positions should be independent of each other acting in the long-term interest of the beneficiaries.
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How to Make an Irrevocable Trust:
An irrevocable trust is an estate-planning tool that allows you to control your assets, provide for your heirs and sidestep some estate and income taxes. Engaging legal counsel to help prepare these documents is recommended, although you may be able to make your own irrevocable trust by following these simple steps.
- Make a list of your assets and the individuals you would like to receive your property upon your death or incapacitation. Keep in mind that once you make an irrevocable trust, it cannot be changed.
Obtain the necessary forms to make your irrevocable trust from an attorney, a qualified trust preparer, a paralegal or on the Internet at websites, such as forms.lawguru.com. Seek legal assistance if you need help completing the forms
Prepare your irrevocable trust to provide for your minor and adult children, grandchildren and any developmentally handicapped heirs.
Take advantage of making an irrevocable trust to exclude unwanted individuals from staking a claim to your estate.
Study your local, state and county laws governing trusts. You may have to complete state-specific documents when preparing yours.
Abide by Internal Revenue Service code regulations if you are making an irrevocable trust to avoid estate and/or income taxes. When that is the case, you (the individual establishing the trust) can't have any power or control-direct or indirect-over the property or income of the trust. Obtain a tax exemption form from the county assessor's office in the county where the property is located.
Verify what must be done to "fund" your trust, including transferring property ownership, deeds and financial accounts.
Have your documents notarized and/or witnessed and, if necessary, recorded with your local county recorder's office to make them official.
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How to Transfer Assets Into an Irrevocable Trust:
The hallmark of an irrevocable trust is the grantor's surrender of ownership interest in the assets of the trust. Generally, under state laws, the irrevocable trust simply cannot be amended, modified or revoked by the grantor. The IRS rules on estate taxation are much stricter, and to have the trust recognized as a separate tax entity outside an estate, the grantor must not have possession of the assets, lingering control over the disbursements to the beneficiaries, or any direct financial interest in the trust assets. This makes irrevocable trusts an ideal vehicle for holding life insurance policies, in which the grantor usually has no stake.
- Identify assets in a trust instrument. To establish a trust, some initial assets must be transferred to serve as the corpus and be named as such in the trust instrument. Additional assets can be added over time, or the entire corpus can be named in the trust instrument.
Establish trust account, if necessary. If the trust is going to own cash or financial assets, these should be held in a separate account. Banks and most retail brokers allow the creation of trust accounts, and will likely need a copy of the trust instrument. Transferring cash, securities or equities constituting all or part of the corpus named in the trust instrument perfects the document, consummating the trust.
Transfer title to the trustee. If the grantor acts as the sole trustee, he risks making the trust defective as an irrevocable trust for tax purposes. To be effective as an irrevocable trust, an independent trustee should possess the title to all trust assets in property. Property can be retitled through a deed. Cash and financial assets can be transferred to an account to which only the trustee has access.
- Purchase life insurance. A life insurance policy can be purchased by the grantor with the trust or trustee (in trust) as the named beneficiary. However, when determining whether the insurance proceeds are eligible for inclusion in the estate for estate tax purposes, the IRS applies a strict incidents of ownership test similar to that used with an irrevocable trust. To prevent estate tax on the insurance proceeds, the grantor should assign all rights in the policy to the trustee or some other individual.
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How to Move an IRA to an Irrevocable Trust:
Unless you are over 59 1/2 years old, transferring assets from an IRA to a trust is undesirable. Doing so would count as a withdrawal and trigger taxation and penalties. Conversely, once you reach 70 1/2 you must start withdrawing at least the required minimum distributions. You can organize your estate so that these distributions are transferred directly to an irrevocable trust.
- Create an irrevocable trust. Despite state law definitions of irrevocable trusts, you must surrender virtually all control over the trust to pass scrutiny by the IRS. This means you must not be the sole trustee and you can't have the ability to access and use the trust assets (whether cash or property) or control their distribution to beneficiaries. Naming multiple beneficiaries will help limit their tax liability. You cannot, however, name another trust or charitable organization as the beneficiary of your irrevocable trust if you intend for it to receive your IRA assets.
Ensure quick distribution. If the income to your irrevocable trust exceeds $9,750, the tax rate will be higher than most individual tax brackets. Therefore, the trustee should be empowered to quickly disburse all income within the trust to the beneficiaries within the year it is received. The powers of the trustee are controlled by the language of the document creating the trust.
Name the trust as beneficiary of the IRA. Contact the institutional custodian of your IRA and notify them that you'd like to change the beneficiary of your account. Name the irrevocable trust as the primary beneficiary on the beneficiary designation form and provide a copy of the trust document.
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How to Protect Your Money From Medicaid in an Irrevocable Trust:
Medicaid is a health insurance program that is funded partially by federal funds and partially by state funds and is operated by the state government. Medicaid eligibility requires that income guidelines be met, including having less than $1,500 in total assets, including savings accounts, IRAs, life insurance plans, any vehicles or homes other than one vehicle and one home and other assets. However, funds in an irrevocable trust is not counted as an asset. The contributor to the trust cannot access the funds, but a family member may be the beneficiary of an irrevocable trust after the contributor dies.
- Contact your local or state Medicaid office to discuss what types of trusts are permitted. State Medicaid policies may vary regarding if certain types of irrevocable trusts may be counted as an asset.
Contact a local bank or life insurance company to set up an approved irrevocable trust fund. If the insurance company or bank does not offer this service, most will be able to refer you to someone that is able to assist you with setting up an irrevocable trust fund.
Meet with the life insurance agent or other licensed individual to set up the terms of the trust. A typical form of an irrevocable trust used is a funeral trust, which is awarded to a family member or friend after the death of the individual in order to help finance funeral costs.
- Make the initial deposit into the trust fund. If you have sufficient funds to cover the entire amount of the trust fund, you can deposit the full amount when the terms of the trust are completed.
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How to Change an Irrevocable Trust:
There are two standards to consider with regards to an irrevocable trust. The IRS has the stricter standard: they consider any trust in which the grantor retains any meaningful control of or interest in the assets, or the power to change the beneficiaries or trustee, to be a grantor trust, and taxable to the grantor. Thus, an irrevocable trust under state law might not be treated as such by the IRS, which carries important income and estate tax implications. While it is not possible for anyone but the beneficiary to alter the terms of an irrevocable trust, there are some creative ways for a grantor to change an irrevocable trust depending on the terms of the trust itself.
Get the beneficiaries to agree. The most common and direct way an irrevocable trust is changed is through agreement by the beneficiaries. This must be done according to the laws of the state governing the trust and must be approved by a state court (often before a probate judge). All the beneficiaries, including those who receive current income and those with future interest, and the trustee(s) must communicate their consent to the court through petition and/or affidavit.
Establish a new trust. If the trustee of the irrevocable trust has wide enough latitude in accessing the assets of the trust and can invest or allocate them, a new trust can be established with somewhat different terms and the assets poured from the old trust into the new one. This is an option in situations where the beneficiaries will not agree to a change in their rights under the trust, and, in such a case, the new trust will have to preserve the beneficiaries' rights.
- Sell the assets. Again, if the trustee is empowered in the original trust document to do so, it is possible for the trustee to sell some or all the assets of the trust to another trust with different terms. This process is not tax free, unless possibly if the original irrevocable trust is already defective and considered a grantor trust by the IRS. As a result of the sale, however, assets that are continuing to appreciate can be sold to a new trust, while the old trust will hold cash.
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How to Change the Trustee of an Irrevocable Trust:
The general definition of an irrevocable trust is that it cannot be modified or revoked by the person who creates it, otherwise known as the settlor or grantor. This is the essential feature of an irrevocable trust. There are some situations, however, in which the trustees or beneficiaries of an irrevocable trust can modify the trust as long as the change does not conflict with a material purpose of the trust as envisioned by the settlor. Such a modification can include changing the trustee. In many instances, such a change will involve petitioning a court, and state probate laws vary.
- Review the trust document for instructions. In most cases, the methods by which the trustee of an irrevocable trust can be changed will be determined by the nature of the trust and the terms of the document itself. Relevant language to look for includes a statement about which state's laws govern the trust, the designation or authorization of a trust protector or any explicit instructions about changing the trustee.
Obtain approval of all beneficiaries. One of the usual preconditions for modifying an irrevocable trust is to obtain the consent of all interested parties, including all beneficiaries. In some states, an agreement among the beneficiaries can be enough to change the trustee, so long as the purpose of the trust is not violated. Some states may interpret the trustee as an interested party, in which case he may be able to prevent this manner of change unless there is formal court intervention.
- Request change from the trust protector. Many trusts do not appoint a trust protector, who acts as a supervisor of the trust. If a trust protector is appointed by the trust document, her powers are usually enumerated in the document. Among these powers is typically the ability to review the actions of the trustee and change the trustee if necessary.
Petition the probate court. If there is a compelling reason to change the trustee, such as gross misconduct or abandonment of trustee duties, a probate court with jurisdiction over the trust can be moved to order a change of trustee.
Obtain permission from the settlor, if he or she is alive. The Uniform Probate Code (Section 411), which has been adopted entirely by 16 states and in part by others, authorizes modification of the trust by the beneficiary if the settlor approves of the change. The settlor may also appoint an agent with the power to provide such consent.
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How to Undo an Irrevocable Trust:
There are two basic types of trusts: revocable and irrevocable. A revocable trust can be amended by the person who set it up, while and irrevocable trust, in most cases, cannot be amended. However, there are circumstances when an irrevocable trust can be changed. Here's how you can go about changing one.
Prove that things are different from when you set up your irrevocable trust to receive the proceeds of your life insurance, so that changes in it are justified. For example, at the time your set it up, you were happily married. Today, after a messy divorce, you are happily remarried with more children, and you want to take care of your new family. Besides, the one child of your first marriage is wealthy and doesn't need your inheritance. Or, you are still happily married but your irrevocable trust names your child, now in his 20's, as its beneficiary if your spouse is no longer alive, and that the child should receive the proceeds in one lump sum. You'd like to change your trust to pay staggered amounts instead, since you think he is likely to spend it quickly, otherwise.
Show that the lawyer who drafted your irrevocable trust did not include what you wanted in it. A claim that such errors in drafting occurred is grounds for making changes.
Consider setting up a new irrevocable trust, and have the trustee transfer the principal of the old trust to the new one. This method can be used only in a few states. This is a good strategy so long as the new trust provides relatively the same rights to the beneficiaries that the old one does. For example, this is a good way for surviving beneficiaries, like children, to be limited in what they receive because the trustee is empowered to dole out the proceeds to them instead of paying them all at once.
Change the contents of your irrevocable trust by getting the approval of all the trust's beneficiaries and the trustee. This is allowed by most states, but it must be approved by the court in your area, as well. If any of the beneficiaries are minors, their interests must be protected by a guardian who is approved by the court. To get the court's approval to make changes, you need to prove that those changes are in their best interest.
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How to File an Irrevocable Trust With the IRS:
An irrevocable trust is a separate taxable entity. It is distinguished from what are called "grantor trusts," the income of which flows through to the grantor's individual tax return. To qualify as an irrevocable trust, the grantor must surrender ownership of all assets transferred to the trust, and they cannot be titled in his name. Though there are no formal requirement to file any forms with the IRS to create an irrevocable trust, for tax purposes it must have its own federal tax identification number and returns must be filed annually if it generates income.
- Apply for FEIN. The IRS provides several methods by which a trustee can apply for a tax ID number for an irrevocable trust. The easiest is probably to complete the interview-style application on the IRS website (see Resources below). Otherwise, the filing of Form SS-4 is required. In either case, the necessary information includes the legal name of the trust, the name of the trustee, contact information for the trust (address and phone number) and the types of business activity in which the trust will engage. The trustee will have to provide his Social Security number, or, if a corporation, its own tax ID.
Compute annual income tax liability. A trust computes its income tax liability the same way an individual or business does, and is allowed most of the same credits and deductions. The tax rates on trusts, however, is a hefty 39.6 percent of all income more than $8,650. The appropriate form to file is Form 1041, U.S. Income Tax Return for Estates and Trusts. A return is only necessary for a irrevocable trust in years in which it generated more than $600 in income, or during which it had a non-resident alien as a beneficiary.
- Complete Schedule K-1. Because of the high tax rate on irrevocable trusts, most distribute their income to beneficiaries each year, who are then taxed at their individual rate. An irrevocable trust is required by the IRS to prepare and file a Schedule K-1, detailing all income distributed by the trust to the beneficiaries. This is helpful in clarifying for the beneficiaries what they must declare as trust income on their individual returns, and makes it easier for the IRS to verify that the income is in fact claimed on the beneficiaries' returns.
Declare charitable donations, if any. A trust that makes contributions to qualified charities and therefore seeks a deduction on its income is considered a "complex trust" by the IRS and is required to file a Form 1041-A, U.S. Information Return for Trust Accumulation of Charitable Amounts.
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How to Prepare Tax Forms for an Irrevocable Trust:
An irrevocable trust is one that cannot be revoked or amended by the person who creates the trust, or the grantor. These trusts are taxed as separate entities and at a fairly high rate, so it's common for them to disburse all or most income to the beneficiaries annually. For tax purposes, the IRS might consider some irrevocable trusts to be grantor trusts and tax them to the grantor individually.
Confirm the type of trust. The IRS treats trusts differently than state laws. For tax purposes, if the grantor or settlor of the trust retains certain powers over or benefits in the trust, it will be considered a grantor trust by the IRS, and the income is taxed to the grantor. If the grantor remains a substantial owner of the trust, it is not irrevocable in the eyes of the IRS, and a separate tax filing is not necessary.
Determine the filing requirement. A trust other than a grantor trust is obligated to file a tax return if it has any taxable income, has more than $600 of gross income in a single year, or has a beneficiary who is a nonresident alien (see Instructions for Form 1041 in Additional Resources below). Otherwise, no filing requirement exists, even for a trust that is not a grantor trust.
File Form 1041. If the trust has a filing requirement according to the previous step, this is the appropriate form (see Additional Resources). This two-page document is similar to an individual tax return and should be straightforward for anyone familiar with preparing individual tax-return documents. Form 1041 must be completed by the fiduciary, or trustee, of the trust or their designated representative.
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Requirements for a Irrevocable Family Trust Agreement:
In an irrevocable family trust, the grantor, or the person giving assets to the trust, relinquishes ownership of the property to the irrevocable trust, which serves as its own entity. As implied by its name, an irrevocable trust may not be terminated or modified by the grantor. With the express written consent of the beneficiary, however, the grantor and trustee may make material changes to the agreement.
- Because the laws governing irrevocable family trusts vary by state, trusts are generally drafted by an attorney and then executed by the grantor. The beneficiary, or future recipient of the funds, may also need to execute the irrevocable living trust. The grantor is responsible for establishing the criteria for how the beneficiary will receive the proceeds from the trust.
- Irrevocable family trusts allow the grantor to establish set rules for when the beneficiary may begin to collect from the trust. Grantors often set up irrevocable family trusts to provide for a child or grandchild's education or to provide family members a set monthly income after the reach a certain age. These provisions must be outlined in the initial agreement for them to be legally binding.
- The irrevocable trust is its own taxable entity, and tax returns are filed under the trust's EIN. Generally, the attorney drafting the trust will help the grantor establish an EIN with the IRS. The trust must file its yearly tax return using IRS Form 1041. Once the funds are distributed to the beneficiary, the beneficiary may assume the tax burden rather than the trust. Because the grantor no longer has control over the assets of the trust, he or she is not responsible for the taxes it accrues yearly. Likewise, creditors may not seek the funds gifted to an irrevocable trust after they are transferred by the grantor.
- A trust is generally used to will property, assets, and money to a beneficiary after the grantor is deceased. Establishing an irrevocable trust and gifting assets to it allows the grantor to avoid some tax penalties. It also ensures that the trust's beneficiaries do not have to go through probate hearings after the grantor is deceased.
- The irrevocable trust generally must have a trustee other than the grantor or beneficiary to manage the trust's funds. Generally, the grantor is responsible for selecting a trustee. Attorneys, banks and private money management companies often serve as the trust's manager and handle accounting matters, investments, property management and, after the death of the grantor, distribution of funds.