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A trust is a legal entity that acts like a paper bag into which you (the "Grantor") put whatever assets you want. On the bag, you put instructions for use of the contents. You can hold onto the bag or give it to someone else. The person who holds the bag must follow the instructions.

Trusts are used in financial planning for a variety of purposes. For example:

  • A trust can be used to provide an income to a person while limiting access to the asset which creates the income. If done far enough in advance of the need, this kind of use can help people qualify for Medicaid long term care.
  • A trust can be used to provide supplemenetal benefits for a person who receives a benefit from the government which is dependent on having limited assets and resources, such as Supplemental Security Income (SSI) and/or Medicaid. (A "Supplemental Needs Trust").
  • A trust can be used to protect assets from creditors.
  • A trust can be used to give an asset that has appreciated in value to charity in a tax advantaged manner. The donor (grantor) or other people can receive an income from the asset before it is ultimately given to charity. These trusts are known as "Charitable Remainder Trusts".

Trusts can also be used in estate planning. Trusts can generally do everything a Will can, and sometimes can do things a Will cannot. For example:

  • A trust can be hold assets for a minor beneficiary, paying living, medical care and education expenses. The trust can be set up to hold the assets indefinitely. A trust can also be set up for a specific time, such as when the child reaches a certain age. At that  time, either the income or principal or both can be passed to the beneficiary or to someone else.
  • A trust can be used to minimize estate taxes. Examples are:
    • A "Bypass trust" where legally wedded spouses take advantage of a combination of the exemption from tax and the passage of assets from one spouse to another tax free.
    • An "Irrevocable Life Insurance Trust" which removes the insurance proceeds from your estate for estate tax purposes.
  • A trust can be used to avoid probate so assets move to heirs without the delay caused by probating a Will and without being subject to public scrutiny.
  • A trust can be used when a fight is expected about which beneficiary gets what. It is more difficult to attack the provisions of a trust than of a Will.

Trusts can be created while you are alive (Living Trusts) or through a Will (Testamentary Trusts).

A Living Trust can either be Revocable (it can be revoked or changed by the person who set it up) or it can be Irrevocable (it cannot be changed after it is created.)

The most popular form of trusts these days is known as a Revocable Living Trust. It is a trust which is creating during the Grantor's life time. The terms can be changed at any time until the Grantor's death at which point the terms become locked-in.

Trusts are sophisticated and complex. While there are many self-help books on the subject, it is advisable not to consider creating any type of trust arrangement without at least consulting an experienced lawyer. As Alexandra Cohn, Esq., a Trust and Estate attorney points out: "Setting up the wrong kind of trust or getting the timing wrong, can result in some pretty expensive mistakes (and that can include significant professional fees in addition to taxes.)"  Plus: "There can be significant differences between the states, so where a person lives makes a difference as to what one chooses to do regarding an estate." A consultation does not have to be expensive. 

A trust does not replace the need for a Will. For information about wills, see Wills 101

For additional information, see:

Edited by: 
Jerry Simon Chasen, Esq. 
Chasen & Associates, P.A. 
Miami, Florida

Irrevocable Life Insurance Trust

An Irrevocable Life Insurance Trust is a trust which cannot be revoked or amended by the grantor which has a life insurance policy in it. The trust is both the owner and beneficiary of a life insurance policy.  An existing policy can be transferred to a trust that is established later, or by a policy can be purchased by a trust in the first instance.

A life insurance policy can get into the trust in one of two ways. It can be transferred to the trust or the trust can purchase the policy.

If an existing policy is transferred, the transfer must be complete and irrevocable. The person who sets up the trust (the Grantor) cannot keep any incidents of ownership in the policy -- including the right to change the terms of the trust or the identity of the beneficiary.

The Grantor cannot serve as trustee.

The Grantor is also prohibited from using the cash value in the life insurance policy, if there is any. That said, it would be ossible for an independent trustee of the trust to loan money to the Grantor.

The trust could be set up so the trustee has the power to change the identity of the beneficiary. Note that the trust has this right,  but the grantor doesn't. The grantor also no longer has a right to the cash value in the policy or the right to sell it such as in a Viatical Settlement or a Life Settlement.

Because of the irrevocable transfer, the life insurance policy is no longer part of the taxable estate of the grantor.

The transfer of an existing policy to the trust is subject to gift tax. The gift is valued on what is technically referred to as "interpolated terminal reserve value." This value is usually close to the cash surrender value, unless the insured is currently uninsurable or in poor health, in which case it can be higher.

With the transfer of an existing policy, if the grantor dies within three years of placing the policy in trust, the death benefit is still in the grantor's estate for estate tax purposes. With a policy that is purchased by a trust in the first instance, the value of the policy is out of the Grantor's estate immediately.

An interesting twist to be aware of when considering an Irrevocable Life Insurance Trust relates to annual contributions to the trust.

  • Any funds contributed to the trusts must be made in a manner that is independent of premium payments.
  • Each contribution must be subject to a right of withdrawal by the beneficiaries for a reasonable period of time. This is known as a "Crummey provision". A Crummey provision gives the trust beneficiaries the right to demand each year from a trust the lesser of:
    • The maximum gift tax annual exclusion; OR
    • The annual contribution to the trust.

The inclusion of a Crummey Provision makes gifts to a trust present rather than future interests and therefore eligible for the annual gift tax exclusion. The right to withdraw must be real and legally possible. Effective notice of the demand right must be given to the beneficiaries each year, as well as an adequate amount of time to exercise the withdrawal power after notice.

An insurance trust is generally part of a relatively sophisticated estate plan, and should not be set up without legal guidance.

Edited by: 
Jerry Simon Chasen, Esq. 
Chasen & Associates, P.A. 
Miami, Florida

Glossary Of Terms Used With Respect To Trusts

Beneficiary: The person who receives benefits from the trust. The beneficiary can receive income, part of the assets, or both.

Grantor: The person who sets up the trust.

Inter Vivos: Lawyer speak for “living” – as in a Revocable Living Trust.

Irrevocable: The trust cannot be amended or revoked.

Revocable: The trust can be amended or revoked by the Grantor.

Trustee: The person who manages the assets in the trust and follows the instructions.

Protection From Creditors

Assets in a revocable trust are not protected from the grantor's creditors. Since the trust is revocable, the assets are still considered to be owned by the grantor for purposes of creditor/debtor law.

If a trust is set up on an irrevocable basis, the assets may be protected from creditors. The situation is similar to giving away the assets. Once you've given the assets away, they are no longer yours. Because they're no longer yours, a creditor cannot go after them.

That said, a trust cannot be used to defraud creditors. If a creditor believes that assets are moved into a trust to defraud creditors, the transfer can be attacked and the assets used to pay creditors.

Trusts are created under the laws of the various states. Not all of the laws are the same. For example, certain states allow a grantor to establish a trust with significant protection from creditors. In other states, that is not possible.

If you are in a financial crunch and want to protect assets, it is advisable to consult with an experienced lawyer.

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