What is an Irrevocable Trust?
An irrevocable trust in Florida is an agreement, allowed by Florida trust laws, among a settlor, trustee, and beneficiaries that cannot be revoked or amended. In other words, the trustmaker, or settlor, cannot take back property after it is assigned to an irrevocable trust. The trustmaker may not add or remove beneficiaries. Transfers of assets to an irrevocable trust amount to a permanent gift of property for the benefit of other people designated as trust beneficiaries. In short, after you put your property in an irrevocable trust you cannot change your mind except under unusual circumstances.
Trust Asset Protection
Under Florida trust laws, property held in an irrevocable trust is usually protected from the creditors of an individual beneficiary. Florida irrevocable trust laws are found in Chapter 736, Florida Statutes, and in common law and court decisions interpreting the laws.
Florida courts have consistently held that a beneficiary’s interest in an irrevocable 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 voluntarily then the beneficiary’s creditors cannot force the assignment to pay the beneficiary’s debts.
Section 736.0502 of Florida law outlines the spendthrift trust protection. Additionally, Florida courts have consistently applied asset protection to irrevocable spendthrift trusts in court rulings. Florida’s trust laws provide 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 irrevocable trust laws include two exceptions to the spendthrift protection.
First, the law 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 a 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. The special creditors may garnish a beneficiary’s interest and distributions from an otherwise protected spendthrift trust.
Discretionary Trust Distributions
There is a separate and distinct protection for discretionary trusts. A discretionary trust agreement provides that the trustee has discretion over the amount and timing of distributions to beneficiaries. Most spendthrift trust include discretionary distributions. However, the legal protection from creditor judgments of discretionary distributions is separate and distinct from the protection of spendthrift language.
Asset Protection for Discretionary Trusts
Section 736.0504(1) of Florida irrevocable trust law protects beneficiaries of discretionary trusts. The law 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 creditors. This protection against forced distributions applies regardless of whether the trust has a spendthrift provision, regardless of whether the trustee’s discretion is subject to an express standard, and regardless of whether the trustee may have abused his discretion.
Protected Beneficiaries as Trustees
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 based upon an ascertainable standard. A typical ascertainable standard of discretion is the health, education, maintenance, and support of the beneficiary (referred to as “HEMS” discretion). If the trust agreement’s provisions include an appropriate ascertainable standard, a debtor who is both a trust beneficiary and the appointed trustee over his own trust share can 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.
Self-Settled Irrevocable Trusts
Under Florida trust law, a self-settled trust is a trust wherein the trustmaker is also a beneficiary. In other words, a self-settled trust is created by a trustmaker for his own benefit. An irrevocable trust provides no asset protection benefits to the trustmaker of a self-settled trust. The trust statute expressly states that regardless of whether a self-settled revocable trust agreement includes a spendthrift provision, the trustmaker’s property transferred to the trust 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 creditor may attack the maximum amount that the trustee may distribute back to the settlor of an irrevocable self-settled trust.
Irrevocable Insurance Trusts
An irrevocable life insurance trust can reduce estate tax liability and protect the death benefits from creditors of the trust’s beneficiaries. An irrevocable life insurance trust, also known as an ILIT, is an irrevocable trust created to own a life insurance policy. The insurance trust, like other irrevocable trusts, cannot be rescinded, amended, or modified in any way. Once the trustmaker 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.
There is an exception under Florida law to permit effective modification of an irrevocable ILIT. The IRS allows people 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 event so long as the trustmaker is the same and the trustmaker is liable for income tax on all trust income.
Benefits of Insurance Trust
An Florida irrevocable insurance trust is sometimes used for estate tax planning. 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 taxable 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.
How to Make a 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 a life insurance trust for purchase and ownership of a life insurance policy:
- In consultation with the client’s professional advisers, the need for the irrevocable trust is established.
- The terms of the trust are designed (including the establishment of beneficiaries and the choosing of both initial and successor trustees).
- 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).
- The attorney drafts the insurance trust.
- The client/trustmaker and trustee sign the insurance trust.
- The trustee applies for an employer identification number (IRS Form SS-4).
- 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.
- The trustee completes the application and pays initial premium.
- Future periodic insurance payments may be paid through the trust, or the grantor (insured party) may pay the premiums directly to the insurance company.