What is an Irrevocable Trust?
An irrevocable trust in Florida is an agreement among a settlor, trustee, and beneficiaries that cannot be revoked or amended. The trustmaker, or settlor, cannot take back property he transfers to an irrevocable trust. The trustmaker may not add or remove beneficiaries, nor can he change the terms and provisions of an irrevocable trust agreement. Transfers of assets to an irrevocable trust are a permanent gift of property for the benefit of other people designated as trust beneficiaries. The trustmaker cannot change his mind about property placed in an irrevocable trust.
An irrevocable living trust in Florida is an irrevocable trust that is made during the lifetime of the trust settlor.
Irrevocable Trust Asset Protection
Florida irrevocable trust laws are found in Chapter 736, Florida Statutes, and in common law and court decisions interpreting trust law. Florida law provides that property held in an irrevocable trust is protected from the creditors of the trust beneficiaries. The most important legal principles that provide asset protection to trust beneficiaries are:
- The spendthrift protection
- The discretionary distribution protection.
Spendthrift Trust Provisions
A beneficiary’s interest in an irrevocable trust established for his benefit by another person is protected from that beneficiary’s creditors if the trust agreement includes a spendthrift clause.
A spendthrift clause states that a beneficiary may not assign or convey his beneficial interest. This trust clause is referred to as a “spendthrift” clause because the provision was initially designed to prevent an imprudent beneficiary from voluntarily squandering his inheritance by assigning his trust interest to another person. Spendthrift protection is based on the idea that a beneficiary’s creditors cannot force a beneficiary to do involuntarily what the beneficiary cannot do voluntarily under the trust document. So, when the trustmaker prohibits the beneficiary from assigning his trust interest voluntarily to a third party, then the beneficiary’s creditors cannot force an involuntary assignment to pay the beneficiary’s debts.
Florida courts have consistently applied asset protection to irrevocable trusts. Florida law provides that a spendthrift provision must expressly restrain both voluntary and involuntary transfers of a beneficiary’s trust interest to protect the beneficiary’s interest from 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 by the trust spendthrift clause.
Florida law makes two exceptions to the spendthrift protection. First, the law prohibits a trustee of an irrevocable trust from withholding a distribution that is required under the trust agreement 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 applies to “special 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.
There is a separate and distinct protection of a beneficiary’s interest in an irrevocable trust agreement that gives the trustee discretion over the amount and timing of distributions to beneficiaries. These trusts are referred to as “discretionary trusts.”
Section 736.0504(1) of Florida 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 regardless of whether the trustee’s discretion is subject to an express standard, and regardless of whether the trustee may have abused his discretion.
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.
The asset protection of a irrevocable discretionary trust applies even when the beneficiary is also the trustee, provided that the trustee’s discretion to distribute property to himself is subject to an ascertainable standard. A typical ascertainable standard for discretionary distributions is the health, education, maintenance, and support of the beneficiary (referred to as “HEMS” discretion). If the trust agreement’s provisions include an appropriate HEMS standard, a debtor who is both a trust beneficiary and the appointed trustee over his own trust share can withhold distributions to protect the trust property from his creditors.
Irrevocable Trust Execution Requirements
An irrevocable trust must be executed properly to be valid. Under Florida law, if the irrevocable trust has any testamentary provisions, then the trust must be executed with the same formalities of a will. That means the trust must be signed in the presence of two witnesses and a notary. Typically the trust will have a self-proving affidavit as well.
Self-Settled Florida Irrevocable Trusts: No Protection
A self-settled trust is a trust where the trustmaker is also a beneficiary. In other words, a self-settled trust is created by a trustmaker for his own benefit.
A revocable living trust is an example of a self-settled trust. An irrevocable self-settled trust provides no asset protection benefits. Florida trust law expressly states that regardless of whether or not a self-settled trust agreement includes a spendthrift provision, the trustmaker’s property transferred to the trustmaker’s trust is subject to the claims of the trustmaker’s creditors. Florida courts have denied creditor protection to self-settled trusts for reasons of public policy.
Irrevocable Insurance Trusts
Irrevocable trusts in Florida are used for reasons other than asset protection. One such purpose is ownership of life insurance policies. 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 with narrow exceptions (discussed below). 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.
An 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 taxable estate of the insured trustmaker for estate tax purposes. In addition, the ILIT can also be structured so that the trust can distribute money 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.
Exception Permitting ILIT Changes
There is an IRS exception for a trustmaker to modify an otherwise 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.
How to Create a Life Insurance Trust
Creation of an Florida 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:
- The professional legal and tax advisors recommend insurance trust and explain its advantages.
- The trustmaker decides the terms of the trust (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 the trustmaker is not insurable.
- The attorney drafts the insurance trust.
- The 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 trustmaker makes an initial gift to the insurance trust to cover the initial premium and the trustee notifies the beneficiaries that a gift is being made to the trust for their benefit.
- The trustee completes the application and pays initial premium.