Irrevocable Trust Overview
By Kevin Taylor
Today’s email is the third in our series of general estate planning tools and techniques.
An Irrevocable Trust is an inflexible, fixed trust. You cannot change or cancel it once it has been signed. Despite the lack of flexibility, an Irrevocable Trust may be the right choice to potentially reduce taxes due on an estate at death. There are far too many variations of irrevocable trusts to discuss in a simple overview, but here is a description of those most commonly used:
Irrevocable Life Insurance Trust (ILIT) (also known as a Crummy Trust)
An ILIT is an Irrevocable Trust that owns one or more life insurance policies. If this type of trust owns insurance policies on your life, the proceeds payable on your death generally should not be included in your estate for estate tax purposes. This type of trust is commonly used by business owners to provide liquid funds necessary to pay estate taxes.
A Marital Trust typically would be created on your death under the terms of your Living Trust. The trust is designed to benefit the surviving spouse and minimize estate taxes. To achieve the tax benefits, the income from the trust must be paid to the surviving spouse after your death. The surviving spouse may have the right to withdraw part or all of the property, and the trustee may be given the discretion to distribute trust principal to the surviving spouse for certain purposes (e.g., health, education, maintenance and support). The surviving spouse would have the right to designate how and to whom the property in the Marital Trust would be distributed upon his or her death.
Qualified Terminable Interest Property (QTIP)
A QTIP Trust typically would be created on your death under the terms of your Living Trust. This trust is designed to benefit a surviving spouse and minimize estate taxes and possibly Generation-Skipping Transfer Taxes. To achieve the tax benefits, the surviving spouse must receive the income from the trust. In addition, the trustee may be given discretion to distribute principal to the surviving spouse for certain purposes (e.g., health, education, maintenance, and support). The major difference between the QTIP Trust and the Marital Trust is that the grantor – not the surviving spouse – would determine how and to whom the trust property is to be distributed on the surviving spouse's death. For this reason, QTIP Trusts are often used in second marriage situations.
By Pass Trust
Also known as Credit Shelter Trust, Family Trust, or Non-Marital Trust. This type of trust would typically be established upon your death under the terms of your Living Trust. It is designed to take advantage of the amount that each of us can give away (during life or at death) without incurring gift or estate taxes. If properly structured, the trust would not be subject to estate taxes in your estate or in the estate of your surviving spouse. Thus, the trust property can pass to your children or other beneficiaries free of estate taxes. The trust usually is structured so the surviving spouse can receive income and principal from the trust.
A Dynasty Trust is designed to remain in existence and benefit multiple generations of a family. In some states, the trust must terminate at some point. In other states, such as South Dakota, the trust may remain in existence forever. A Dynasty Trust is a great way to preserve assets for future generations.
Clients who wish to transfer wealth during life can create gifting trusts that are created to qualify contributions for the annual gift tax exclusion. These trusts are generally referred to as 2503 (b), 2503(c), or irrevocable trusts with crummy trust provisions. They are excellent to leverage annual exclusion gifting when there are appreciating assets involved such as business interests.