Part 1: Drafting Trusts to Create Flexibility
Maya Angelou once said, “If you don’t like something, change it.” Unfortunately, this sage advice does not apply to irrevocable trusts. Or does it?
An irrevocable trust generally refers to any trust that cannot be modified or revoked after it is created. When an individual transfers assets to an irrevocable trust, that person is no longer considered to be the owner of those assets. Irrevocable trusts are commonly recommended by estate planning attorneys as part of a comprehensive estate tax planning strategy. Nonetheless, many clients are reluctant to utilize irrevocable trusts because they are unwilling to relinquish control of their assets to a trust that cannot be modified. Is this reluctance justified? Is an irrevocable trust really irrevocable?
This article is the first of a two-part series addressing this question. Part one will discuss drafting techniques that can be utilized by an attorney to create flexibility in an irrevocable trust. Part two will explore various methods of modifying certain terms of an irrevocable trust after it has been established.
The only constant in life is change. Family dynamics change. Personal wishes change. Laws change. With respect to irrevocable trusts, the easiest way to account for the inevitability of change is to draft the document to provide maximum flexibility. This can be accomplished in a variety of ways, including the following: providing the grantor with certain powers, providing the beneficiaries with certain powers, and appointing a trust protector.
When creating your irrevocable trust, you may want to discuss with your attorney giving yourself, as grantor, the power to remove and replace a trustee. By doing so, you can protect against a trustee who fails to perform his or her duties in a satisfactory manner. Your attorney will be careful to emphasize that a replacement trustee cannot be related to or subordinate to the grantor. Otherwise, you risk losing the estate tax benefits for which you established the trust in the first place.
You may also want to discuss with your attorney giving yourself, as grantor, the power to cancel or modify withdrawal rights. In some types of irrevocable trusts, such as an irrevocable life insurance trust, the grantor gives the beneficiaries the power to make withdrawals from the trust when contributions are made. By doing so, the grantor ensures that contributions made to the trust qualify as annual exclusion gifts. However, the intention is for the beneficiary to not exercise this power so that the funds can be used for other purposes (e.g., to pay life insurance premiums). By reserving the right to cancel or modify withdrawal rights, you will be able to deal with uncooperative beneficiaries.
For the same reasons that you would give yourself, as grantor, the power to remove and replace a trustee, you may also want give your beneficiaries the power to do so. In order for the beneficiaries to exercise this power, you can require that they act unanimously or by a majority vote.
You may also want to give your beneficiaries a power of appointment. A power of appointment allows a beneficiary to control the ultimate distribution of the trust assets. By giving a beneficiary a power of appointment, you can protect against unforeseen circumstances that would have made the original distribution terms of the trust undesirable. There are two basic types of powers of appointment – limited and general. A limited power of appointment allows the beneficiary to direct the ultimate distribution of trust assets among a limited group of recipients. A general power of appointment allows the beneficiary to direct the distribution of trust assets without limitation. Be aware that if you give a beneficiary a general power of appointment, the assets in the trust may be includible in his or her estate. This may conflict with the ultimate goal of certain irrevocable trusts.
When working with your attorney to establish an irrevocable trust, you may want to consider naming a trust protector. A trust protector is a person appointed to oversee a trust to ensure that it is not adversely affected by any changes in the law or circumstances. The powers granted to a trust protector can be as narrow as removing and replacing a trustee or as expansive as altering the terms of the trust to account for any unforeseen changes.
As you can see, with proper drafting, an irrevocable trust is not really irrevocable. Therefore, you should not be reluctant to take advantage of the various benefits that an irrevocable trust can provide. If there is something amiss with your flexibly drafted trust in the future, you, the beneficiaries, or the trust protector can heed Maya Angelou’s advice and change it.
Stifel does not provide legal or tax advice. You should consult with your legal and tax advisors regarding your particular situation.