Florida Irrevocable Trust

An irrevocable trust in Florida is an effective asset protection tool when drafted correctly and used in the appropriate circumstances. Property held in an irrevocable trust is usually protected from the creditors of an individual who is a beneficiary of the trust. Florida’s trust laws are found in Chapter 736, Florida Statutes, and in common law and court decisions interpreting the Statutes.

Spendthrift Provisions

Florida spendthrift provisionFlorida courts have consistently held that a beneficiary’s interest in a trust established for his benefit by another person is protected from the beneficiary’s creditors so long as the trust agreement includes a “spendthrift provision.” A spendthrift clause typically states that a beneficiary may not assign or convey his beneficial interest. This type of trust language is called “spendthrift” because it is supposed to prevent a careless beneficiary from squandering his inheritance. Florida courts have held that if the trustmaker prohibits the beneficiary from assigning his beneficial interest then the beneficiary’s creditors cannot force the assignment to pay the beneficiary’s debts.

Section 736.0502 of the Florida Statutes expressly recognize the protections afforded by spendthrift provisions, and Florida courts have for a long time consistently applied asset protection to irrevocable spendthrift trusts. Florida’s trust statute provides that a spendthrift provision must expressly restrain both voluntary and involuntary transfers of a beneficiary’s trust interest. Unless both types of transfers are prohibited in the trust agreement, the spendthrift provision will not meet the statutory requirements for creditor protection against a beneficiary’s creditors. After a trustee makes a distribution from a spendthrift trust to a beneficiary, the money in the beneficiary’s hands is no longer protected from the beneficiary’s creditors.

Florida’s trust statute includes two exceptions to spendthrift protection. First, the statute prohibits a trustee from withholding a distribution otherwise due to be paid to a beneficiary solely to protect the distribution from the beneficiary’s creditors. Overdue mandatory distributions can be garnished from a spendthrift trust. The second exception from spendthrift trust protection includes so called “exception creditors” or “creditors of last resort.” These special creditors include claims by a beneficiary’s child, claims of former spouse for support and maintenance, and claims by creditors (such as an attorney) who have provided services for the protection of a beneficiary’s interest. Another exception is made for claims by a state in the U.S. to the extent provided in a separate law.

Discretionary Distribution Provisions

The next part of Florida trust statute with asset protection implications is found in Section 736.0504(1) which protects beneficiaries of discretionary trusts. The statute states that a beneficiary’s creditor cannot compel a trustee to make a discretionary distribution of income or principal to a trust beneficiary when the distribution would become vulnerable to the beneficiary’s creditor claims. This protection against forced distributions applies whether or not the trust has a spendthrift provision, whether or not the trustee’s discretion is subject to a standard, and whether or not the trustee may have abused his discretion. The same protection of the trustee’s discretionary distributions applies to trusts where the beneficiary is also the trustee, provided that the trustee’s discretion to distribute property for his own benefit is limited by an ascertainable standard of discretion. A typical ascertainable standard is the health, education, maintenance, and support of the beneficiary. As long as the trust agreement’s provisions for discretionary distributions includes an appropriate standard, a debtor who is both a trust beneficiary and the appointed trustee over his own trust share can exercise discretion to withhold distributions in order to protect the trust property from his creditors.

A Florida appellate court held that “exceptional creditor” or “creditor of last resort” may garnish payments payable to a debtor/beneficiary from a discretionary trust. The exceptional creditor may not compel distributions, but it may obtain a continuing writ of garnishment against payments authorized by the trustee.

Living Trusts and Other Self Settled Trusts

The asset protection provisions of Florida trust law apply only to trusts set up by a trustmaker other than the beneficiary. A trust established for one’s own benefit, a so called self-settled trust, provides no asset protection benefits under the new trust statute. The new trust code states that, whether or not a self-settled revocable trust agreement includes a spendthrift provision, the trust property is subject to the claims of the settlor’s creditors. This exception is consistent with several Florida court decisions refusing creditor protection to self-settled trusts for reasons of public policy. A common self-settled trust is a revocable living trust used for estate planning. A living trust provides the settlor/trustmaker no asset protection. A creditor may attack the maximum amount that the trustee may distribute back to the settlor of an irrevocable self-settled trust.

Irrevocable Insurance Trusts

Florida irrevocable trust drafted by Alper LawThe insurance trust is an estate planning tool that can reduce estate tax liability and also protect the death benefits from creditors of the trust’s beneficiaries. An irrevocable life insurance trust (“ILIT”) is no more than an irrevocable trust created for the principal purpose of owning a life insurance policy. As with any other trust, the insurance trust is a contract between a grantor and a trustee to administer certain property, in this case an insurance contract, for the benefit of named beneficiaries. Generally speaking, the insurance trust, like other irrevocable trusts, cannot be rescinded, amended, or modified in any way after it is created. Once the grantor contributes a life insurance policy to the trust, he cannot later reclaim ownership of the policy or change the terms of either the policy or  the trust. However, there is a recent IRS ruling that permits people effectively to modify an insurance trust by creating a new trust with different trust provisions and then assigning the life insurance policy to the newly formed trust. The IRS does not consider the assignment of the life insurance to the new trust to constitute a taxable even so long as the trustmaker is the same and the trustmaker is liable for income tax on all trust income.

One of the primary reasons for executing a life insurance trust is estate tax considerations. If an ILIT is properly structured, the death benefits paid to the trust will be free from inclusion in the gross estate of the insured. In addition, the ILIT can also be structured so that the trust will provide benefits to the insured’s surviving spouse without inclusion in the surviving spouse’s gross estate. An ILIT that includes a spendthrift provision or discretionary distributions to ultimate beneficiaries protects death benefits retained in trust from future creditors or divorced spouses of the named beneficiaries.

Procedure to Establish Life Insurance Trust

Creation of an insurance trust involves coordination between the financial adviser who recommends and sells the policy, an attorney who drafts the legal trust documents, and the person named as trustee of the trust. The following are suggested procedures for establishing an insurance trust for purchase and ownership of a life insurance policy:

  1. In consultation with the client’s professional advisors, the need for the irrevocable trust is established.
  2. The terms of the trust are designed (including the establishment of beneficiaries and the choosing of both initial and successor trustees).
  3. Medical examination procedures should be commenced. (There is no need to draft a trust if clients are not insurable.) The insured should not sign anything at this point other than in his or her capacity as insured (i.e., not as the owner or applicant).
  4. The attorney drafts the insurance trust.
  5. The client/trustmaker and trustee sign the insurance trust.
  6. The trustee applies for an employer identification number (IRS Form SS-4).
  7. The trustee applies for life insurance and signs the application as insurance owner. If the insurance company requires a check with the application, the application should not be commenced until the following three steps are completed: (i) the grantor/trustmaker makes an initial gift to the insurance trust to cover the initial premium; (ii) a checking account is opened in the name of the trust; and (iii) the trustee notifies the beneficiaries that a gift is being made to the trust and that they have rights of withdrawal (referred to as “demand notice”). The demand notice should be given and the period for withdrawals allowed to lapse prior to payment of any premiums to the insurance company.
  8. The trustee completes the application and pays initial premium.
  9. Future periodic insurance payments may be paid through the trust, or the grantor (insured party) may pay the premiums directly to the insurance company.

If you have questions about how an irrevocable trust might work in your overall estate or asset protection planning, give us a call to schedule an appointment.

What to Do Next

We help families with an overall estate plan, including wills, trusts, and any other documents needed.
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Alper Law
Florida Irrevocable Trust
November 4, 2015