A Brief Introduction About the Irrevocable Trust
An irrevocable trust is a trust where the terms under which the trust has been created cannot be changed or modified without the consent of the beneficiary. The definition of an irrevocable trust is a trust that cannot be revoked. Through such a trust, the grantor transfers the ownership of the assets to the trust, and hence the grantor no longer has any ownership over any of such assets. Once the grantor places an asset in an irrevocable trust, it is a gift to the trust, and the grantor cannot revoke it.
In most cases, a trust is considered to be irrevocable unless the grantor specifies otherwise. The grantor can dictate the terms of the trust, the rules under which the trust shall be managed and for what purposes the assets of the trust may be used.
Revocable Vs Irrevocable Trust
A revocable trust can be withdrawn or altered at any time as long as the grantor of the trust is mentally competent. The grantor can cancel the trust and reclaim the property at any time before his death. Whereas an irrevocable trust can be modified only with the permission of the beneficiary. Thus the main difference between revocable and irrevocable trusts is the manner in which the trust can be modified by the grantor.
An irrevocable trust can relieve the grantor from tax liability attached to the income that is generated by the asset. In a revocable trust, the ownership of the assets is still with the grantor and hence he will be liable to pay tax on the income generated by such assets.
People Involved in the Irrevocable Trust
There are three parties connected in any trust – one is the grantor i.e., the person who is creating the trust; second is the trustee who manages the trust and carries out all the functions; and the third party is the beneficiary for whom the property is held in trust and who will receive the benefits of the trust. The trustee determines how the assets shall be invested and how the property shall be distributed when the creator of the trust dies.
Purpose of the Irrevocable Trust – Why Do You Need It?
There are many purposes for which an irrevocable trust is created. One of the main reasons for the creation of this trust is for estate and tax purposes. The assets that have been granted to the trust are no longer owned by the grantor, and hence these assets will not be calculated as a part of the grantor’s taxable income. Hence he will not be required to pay tax on the income that the assets generate.
Another purpose is to save the property from any creditors. As the property belongs to the trust, any creditor or judgment holder cannot touch the property since it no longer belongs to the grantor. The creditor cannot take property from someone who is not a party to the lawsuit or a party to the debt. Therefore this type of trust is beneficial for people who work in a profession that puts them at risk of many lawsuits.
When the beneficiary receives income and any other distribution from the trust, he will have to pay tax on such income. However, when the beneficiary receives a distribution of the principal balance of the trust, that will not be taxable as that amount is already taxed before it is placed in a trust. The interest that accumulates is taxable in the hands of either the beneficiary or the trust.
Contents of the Irrevocable Trust
The following are the clauses that must be included in an irrevocable trust agreement:
- Trust property: The agreement must clearly mention which assets are to be transferred to the trust.
- Beneficiaries of the trust: The names of the beneficiaries for whom the trust has been created and for whom the property has been held in trust must be mentioned clearly.
- Powers of the trustee: There must be a clause detailing the powers of the trustee. All the acts that he has the right to perform must be mentioned. Such powers may include the right to rent or lease the properties of the trust, the right to sell or exchange the property, to borrow or lend money and other any other powers that may be provided for.
- Irrevocability: The agreement must clearly state that the trust is irrevocable in nature and that the grantor waives all rights to modify, revoke, or terminate the terms of this agreement.
- Compensation of the trustee: This clause can mention the compensation that shall be payable to the trustee, or it can state that the trustee has waived the right to receive payment for his services.
- Successor trustees: The clause shall give power to the trustee to appoint his successor trustee.
How to Draft the Irrevocable Trust
The following are the steps to follow while drafting an irrevocable trust agreement:
- The creator of the trust must decide the purpose for which he desires to create a trust and who shall be the beneficiary of the trust.
- The grantor shall choose a trustee who he believes will manage the trust well and perform all the functions that are required of him.
- The grantor shall draft an irrevocable trust agreement and provide for all the important details that are required to make the agreement foolproof. This will include the assets that are to be transferred to the trust, the names of the beneficiaries and the powers of the trustee.
- The agreement must be thoroughly verified to make sure that all the details are correct as it cannot be modified once it is created.
- The agreement must be signed by the grantor, and the trustee and the document must be notarized.
Advantages and Disadvantages of the Irrevocable Trust
Below are the pros and cons of an irrevocable trust:
- A major benefit of this type of trust is that, as mentioned before, the grantor will not have any tax liability for the income that is generated by the assets transferred to the trust. These assets no longer belong to the grantor and will not be part of his income.
- Another advantage of an irrevocable trust is that the grantor can set certain conditions as to how the assets of the trust will be distributed and hence he can prevent the beneficiary from misusing the assets of the trust.
- This type of trust protects the assets of the trust from any lawsuit that has been filed against the creator of the trust or from any creditors of the grantor.
- Creating such a trust helps to avoid probate. Through this trust, the grantor can transfer ownership of the assets to a person of his choice, and hence, there is no need for probate.
- A disadvantage of an irrevocable trust is that once it is created, it is very difficult to modify the trust formation documents. The documents can be amended only in very rare circumstances.
What Happens in Case of Violation?
If the terms of the irrevocable trust are violated by the trustee, there may be a number of consequences such as removal of the trustee, the trust being revoked by a court as well as a civil lawsuit or a criminal case. Where the trustee has violated the terms of the trust, a court can replace the trustee, alter the terms of the trust or revoke the trust entirely and distribute the remaining assets held by the trust, if the court believes it is in the best interests of the beneficiaries.
Alternatively, a civil lawsuit is frequently a viable remedy for either the grantor or beneficiaries of the trust. One of the most common violations is that the trustee misappropriated the assets of the trust. Anyone who was injured by such a violation may be entitled to file a civil lawsuit(1) based on fraud, or a similar claim, in an attempt to recover monetary damages for the violation. A criminal case for fraud may also be filed against the trustee.
In conclusion, an irrevocable trust is one where the terms of the trust can be easily modified or revoked by the grantor of the trust. The terms of the trust are set in stone once it is created and can be amended only in exceptional circumstances.
Once the trust is created, the ownership of the assets is transferred to the trust, and the grantor no longer has any rights over it. However, this trust is very beneficial and can be used for a variety of purposes. As mentioned before, the major reasons why such a trust is created is for reducing the tax liability of the grantor and for separating the assets of the trust from the assets of the grantor.