TRUSTS: LIVING, REVOCABLE, IRREVOCABLE, INTER-VIVOS. WHAT THE H**L DOES ALL THIS MEAN?

TRUSTS: LIVING, REVOCABLE, IRREVOCABLE, INTER-VIVOS...

I AM SO CONFUSED.

WHAT THE H**L DOES ALL THIS MEAN?

A common question when meeting with a client regarding their intended estate plan is, “There are so many different types of trust, what do I need?”

While there appears to be quite a litany of trusts, it is really not as complicated as it sounds.

Basically there are two types of trust: Revocable and irrevocable. Each one serves a special and independent role in an estate plan. For simplicity's sake, when discussing a trust, one is normally referring to a revocable trust.

Most trusts are nothing more than a substitute for a Last Will and Testament. The terms revocable trust, living trust, and inter-vivos trust are generally the same thing, and like so many other things in life, there may be a geographic preference or individual preference for the name used. However, at the end of the day, they are the same thing, except for rare circumstances.

As a substitute for a will, a trust's primary purpose is to distribute the deceased’s estate to the named beneficiaries without the need of probate, involving the court. PERIOD.

Before delving into irrevocable trusts, I should mention that a lot of clients get wrapped up in the "irrevocable" concept. They do not want someone to later change their estate distribution plans. I understand this concern, but rest easy; these revocable trusts contain provisions that allow the client to amend or revoke the terms of the trust during the client’s lifetime. Other provisions in the trust make it irrevocable on the client's death.

So, what is the purpose of an irrevocable trust? The purpose of an irrevocable trust is normally to move assets outside the client’s control and ownership for purposes of eliminating or reducing estate taxes.

In discussing estate taxes and irrevocable trusts, it is first important to note that in today’s world, an estate under $10,000,000.00 is not subject to federal estate tax. Therefore, at least until estate tax laws change the issue of estate tax elimination or reduction, it is limited to only the persons having estates nearing or exceeding $10,000,000.00, which excludes myself as well as most people I know.

However, I do think it prudent to clear the water on how an irrevocable trust works, and for this example I will discuss one of the most common types of irrevocable trust: An irrevocable life insurance trust.

Presume a client has an estate worth $11,000,000.00, which means he has $1,000,000.00 subject to estate taxes, which will amount to approximately $450,000.00. In these cases, one of the easiest ways to address this future liability is to create an irrevocable life insurance trust. The trust then acquires a life insurance policy payable upon the death of the client. Normally, the amount of the policy would be in the anticipated amount of estate taxes, in this case around $450,000.00. Please note, however, the client is not a trustee or owner. Rather, normally, a child is the trustee, but in no case can the client be a trustee or a beneficiary. While there are several other moving parts, the client gifts to the trust the amount of the insurance premium each year, which is then paid to the insurance company. Upon the death of the client, the policy proceeds are paid to the trust. Because the trust was not owned or controlled by the client, the policy proceeds are not included in the client’s estate.

Please note that, if the client had personally owned and controlled the policy, then their estate would have been $11,450,000.00, which is the original estate of $11,000,000.00 plus the $450,000.00 insurance proceeds. However, because the $450,000.00 policy was not attributable to the client, their estate remains at $11,000,000.00 and the $450,000.00, insurance proceeds are used to pay the estate tax liability.

In conclusion, with today’s current estate tax laws, when discussing trusts, most references are to a trust that is revocable and only intended to be a substitute to a Last Will and Testament. However, it always good to understand the difference when the guys at the coffee shop are saying what you need or don’t need.