What is an Irrevocable Trust
What is an Irrevocable Trust. Common Mistakes to avoid, and Why they are the best way to protect your assets.
What is Irrevocable Trust
An irrevocable trust cannot be revoked or undone by the grantor once it has been established.
Irrevocable trusts offer the true means of asset protection. Irrevocable trusts cannot be altered or undone by creditors, and are thus immune from litigation.
However, as with many things, this major benefit comes with a price: a grantor would have to give up control and ownership of the asset in order to gain protection.
Nonetheless, especially in the case of those who are extremely wealthy, there are several circumstances whereby an irrevocable trust would be the ideal way to go: if you know that you would certainly gift your assets to your beneficiaries, and if you know that you definitely do not need the assets for your financial security.
Common Mistakes to avoid with Irrevocable Trusts
When creating an irrevocable trust, you must be careful to appoint a trustee that the courts would consider sufficiently independent, and not ‘at an arm’s length’. Your spouse or close relatives would thus not be eligible. Similarly, even close personal friends may be scrutinized by the courts. If the courts discover that the trustee does not act independently of the grantor, the courts will ignore the trust and allow creditors to reach the trust assets.
Thus, corporate trustees would make a good choice of a trustee. Examples include a bank, or a trust company.
Gifts to the trusts will be heavily scrutinized under fraudulent transfer laws, as there is no ‘for value’ exchange – as is the case for LLCs and FLPs.
Clauses you must include
As Jarvis and Mandell suggest, there are two clauses that irrevocable trusts must have in order to properly shield the beneficiaries from the creditors:
First, include a spendthrift clause, which allows the trustee to withhold income and principal, which would ordinarily be paid to the beneficiary, if the trustee feels the money could or would be wasted or seized by the beneficiary or the beneficiary’s creditors.
This clause also prevents a wasteful beneficiary from spending trust funds or wasting trust assets – the trustee can stop payments if the beneficiary spends too quickly or unwisely.
Another benefit of this clause is that it protects trust assets from the creditors of your beneficiaries. If the beneficiary and the trustee are at arm’s length (as determined by the courts), then creditors are in no position to force payments from the trust. They only have a right to the payments paid by the trustee to the beneficiary.
Second, include an anti-alienation clause, which also protects trust assets from the beneficiary’s creditors. This prohibits the trustee from transferring trust assets to anyone other than the beneficiary. Thus, this effectively cuts off any possible fund from the trust to your beneficiary’s creditors. Your trustee is legally bound to only pay trust income or principal to the named beneficiaries.