Set in Stone

The most common type of estate planning instrument is a revocable living trust.  Because it is revocable, you can change it at any time.  Your trust might have a provision to give a $10,000 gift to your favorite nephew after your death and next week you can increase that gift, decrease that gift, or completely take it out as if it were never there in the first place by signing a trust amendment.

Most people like the flexibility of revocable trusts because circumstances change over time.  However, there are occasions when establishing an irrevocable trust makes sense.  Below is a summary of some of the most common types of irrevocable trusts and their purposes.

Irrevocable Life Insurance Trust (“ILIT”)

The death benefit proceeds of a life insurance policy that you own at the time of your death are included in your estate for estate tax purposes.  If you have concern that the total value of your estate might exceed your estate tax exemption, you might consider establishing an Irrevocable Life Insurance Trust (“ILIT”) to own your policy.  If the ILIT owns the policy from the beginning, or if you survive at least three years after transferring an existing life insurance policy to an ILIT, then the death benefit proceeds will not be subject to estate tax.

Qualified Personal Residence Trust (“QPRT”)

It is common for your most valuable asset to be your personal residence.  If you are concerned that the value of your residence will create an estate tax, you might want to consider establishing a Qualified Personal Residence Trust (“QPRT”).  The QPRT is a special type of irrevocable trust that allows you to make a gift of a future interest in your residence to your children or other beneficiaries in a way that greatly minimizes the wasting of your gift and estate tax exemption.

Bypass Trust

The “Bypass Trust,” also known as a “Family Trust,” an “Exemption Trust,” a “Credit Shelter Trust,” or a “B Trust,” allows you to benefit your surviving spouse and/or other family members while utilizing your estate tax exemption to mitigate or completely eliminate the application of the estate tax upon your death.  

Qualified Terminable Interest Property Trust (“QTIP”)

If you make a gift to your surviving spouse who is a U.S. Citizen, you do not have to worry about the size of your estate due to the “unlimited marital deduction,” a concept that there should be no estate tax upon any gift to a spouse who is a U.S. Citizen.  However, you might be uncomfortable with making a gift to a spouse without any strings attached.  A Qualified Terminable Interest Property Trust (“QTIP”) allows you to make a gift to your spouse, take advantage of the unlimited marital deduction, while still being able to control distributions of principal during your spouse’s lifetime and ultimately how the remainder of the trust is distributed upon your spouse’s death.  QTIP’s are popular in second marriages where there are separate children.  

Qualified Domestic Trust (“QDOT”)

The unlimited marital deduction described above is only available to surviving spouses who are U.S. Citizens.  If a surviving spouse is not a U.S. Citizen, in order to utilizing the unlimited marital deduction, a Qualified Domestic Trust (“QDOT”) should be established.  Among other requirements, the QDOT mandates that at least one co-trustee of the trust be a U.S. Citizen so the federal government retains jurisdiction over the trust assets.

Special Needs Trust (“SNT”)

Individuals with special needs might be reliant upon means-tested government benefits for health care and other support.  In order to be eligible for such benefits, the recipient’s total assets must be below a specified threshold.  If the recipient were to receive an inheritance without any restriction, the inheritance could jeopardize the eligibility for public benefits.  However, by establishing a Special Needs Trust (“SNT”) for that person, the receipt of the inheritance will not affect the person’s public benefits.  There are different kinds of SNT’s, including a first-party SNT and a third-party SNT.  Strict rules must be followed in the drafting and the administration of SNT’s in order for them to be effective.

IRA Trust

Individual Retirement Arrangements, or “IRA’s,” are popular vehicles for retirement savings.  Financial institutions that hold and manage IRA’s provide beneficiary designation forms that allow you to name beneficiaries of your IRA’s upon your death.  You might decide to name individuals as beneficiaries of your IRA, or you might decide to name a trust for the benefit of your beneficiaries for a variety of reasons such as asset protection and management for young or financially irresponsible beneficiaries.  IRA’s involve many nuanced taxation rules that are further complicated by involving trusts.  When naming a trust as a beneficiary of an IRA, it is important to establish a carefully drafted IRA Trust that features specific provisions to handle these complex rules.

Gifting / Inheritance Trust

The general rule in California as well as the majority of states is that you cannot establish a trust for yourself with your own assets in order to provide yourself with asset protection.  However, if you gift assets to a trust that you establish for the benefit of a third party, you can provide that third party with significant asset protection if the trust is drafted in a specific manner.  With the prevalence of divorce and litigation, you might want to consider including asset protection features for the benefit of your beneficiaries whenever making a lifetime or testamentary gift to a third party.  A properly drafted and administered Gifting or Inheritance Trust can give your beneficiaries significant protection from divorce and litigation.

Domestic Asset Protection Trust (“DAPT”)

Although the majority of states do not allow you to provide yourself with asset protection by establishing a trust for your own benefit with your own assets, there are several states that do allow this kind of arrangement.  A Domestic Asset Protection Trust (“DAPT”) can provide you with asset protection of your own assets under certain conditions.  Some of the most popular jurisdictions that allow DAPT’s include Nevada, Delaware, and Wyoming.

KRASA LAW, Inc. is located at 704-D Forest Avenue, Pacific Grove, California and Kyle may be reached at 831-920-0205.

Disclaimer: This article is for general information only.  Reading this article does not establish an attorney/client relationship.  Before acting on any of the information presented in this article, you should consult a competent attorney who is licensed to practice law in your community.