Irrevocable trusts have been used for decades to reduce the taxable estates of their grantors and also to fulfill other functions. But their use resulted in the loss of control over the assets that were placed inside them, and this could create problems during estate settlement in some cases. But several improvements and additional provisions have been added to these trusts in recent years, and they are now considerably more versatile instruments than before. Wealthy taxpayers who are looking to reduce their taxable estates may now be able to use these trusts to accomplish objectives that were previously out of reach.
How They Work
As the name implies, irrevocable trusts differ from their revocable cousins in their inability to be changed after they are created. While the terms of a revocable trust can always be altered as long as at least one of the grantors is still living, the instructions that are written into irrevocable trusts cannot be altered once the trust has been established. This can be a potential drawback for those who wish to use them, as they cannot always accurately predict the future circumstances that may occur when the trust is being used or its assets dispersed. But several new innovations in trust design are helping to alleviate this disadvantage. While traditional irrevocable trusts usually only had one or perhaps a small group of trustees that managed all of the administrative details of the trust and its corpus, today’s irrevocable trusts will often divide those tasks among a much larger group of people. This allows for a more efficient division of labor and a higher level of management expertise.
A list of the possible positions that modern trustees can be placed in includes the following: (For more, see: HNW Estate Planning: How Advisors Can Serve This Niche.)
- General Trustee – This person takes on the traditional administrative tasks associated with trust management such as record keeping and filing the tax return for the trust each year. Having a general trustee meets one of the key criteria of several states that have favorable trust laws.
- Investment Trustee – This person oversees the management of all investments that are placed inside the trust. However, this person may not be the one actually placing trades or actively managing the trust assets. Trusts that have this type of trustee are known as designated trusts. Not all states allow for this type of trustee.
- Distribution Committee – This is either a single or group of fiduciaries that oversee any distributions that are made from the trust. This position is often best held by an institution that is independent of the trust and the grantor, as the power that it holds is tax sensitive.
- Trust Protector – This position is also fiduciary in nature and gives the trustee the power to fire or replace the other trustees in the trust. This prevents the misuse or abuse of power by other trustees and protects the grantor and beneficiaries. The protector can also change the laws that govern the trust as well as the location of the trust. The exact titles and powers that come with this position can vary widely from trust to another.
Modern irrevocable trusts also often have several other non-trustee positions that can be filled, depending upon the wants and needs of the grantor. These positions include: (For more, see: Estate Planning Tips for Financial Advisors.)
Loan Director – The person in this appointed position has the authority to make loans to the grantor of the trust. This provision ultimately helps the trust to be classified as a grantor trust that passes all income through to the grantor for tax purposes.
Substitutor – This person has the ability to switch assets of equal value into and out of the trust. This can allow the trust to move out highly appreciated assets in exchange for cash in order to preserve a step-up in basis and thus reduce capital gains tax.
Charitable Selector – This person has the authority to name a charitable entity as an additional beneficiary for the trust.
Additional Beneficiaries – This gives a designated person the power to add a non-charitable beneficiary. This is often done so that the grantor can be named as an additional beneficiary if he or she ever has a need to access the trust assets again after the trust has been established for any reason. (For more, see: Why Advisors Should Sidle Up to Estate Attorneys.)
The Bottom Line
Today’s irrevocable trusts come with many provisions that were not commonly found in older versions of these instruments. These additions allow for much greater flexibility in trust management and distribution of assets. Provisions such as decanting, which allows a trust to be moved into a newer trust that has more modern or advantageous provisions can ensure that the trust assets will be managed effectively now and in the future. Other features that allow the trust to change its state of domicile can provide additional tax savings or other benefits. (For more, see: What High-Net-Worth Clients Value and Need.)