The “irrevocable” label might have some clients feeling like they are locked into previously established irrevocable trusts for life, which might not always be the case. There are many reasons why a client might remain interested in preserving an irrevocable trust. But after the fiscal cliff deal made the generous $5 million estate tax exemption and spousal portability permanent, there are equally strong reasons why a client might prefer to terminate.
In some cases, a client who no longer wishes to incur the expense of maintaining an irrevocable trust may be able to terminate. The choice to terminate will force clients to reevaluate insurance and other trust-held assets and lead to what are often long overdue replacement or reallocation discussions.
When can an irrevocable trust be terminated?
Because the distinguishing feature of an irrevocable trust is that it is supposedly not possible to terminate, it may not be intuitive to assume that an otherwise irrevocable trust may be terminated based on the terms of the trust itself, but this is often the case. Many trusts contain provisions that allow the trustee to distribute the trust assets to the beneficiaries of the trust or to accelerate distributions that were set to occur at a much later date.
Further, many irrevocable trusts allow a trustee to terminate and distribute the trust assets if the trust contains assets that are worth relatively little. Bypass trusts often contain a provision that allows the trustee to terminate the trust and distribute the assets to the surviving spouse after the death of the first spouse. With the cooperation of the trustee and beneficiaries (who are often the client’s children), an irrevocable trust may be terminated based on its own terms.
The key to these strategies is a cooperating trustee and, in some cases, beneficiaries who agree with the strategy. If the trustee is unwilling to allow termination, your clients may have to petition the courts in order to unwind an irrevocable trust.
Considerations upon termination: What the client needs to know
Many clients established irrevocable trusts to protect against uncertainty in the estate tax arena — estate tax rates were set to rise and the exemption level was set to decrease. Of course, this did not happen, which in and of itself may eliminate the need for many middle-class clients to incur the expense of maintaining a trust to shelter their assets.