The general rule (IRC Sec 2036(a)) is that if the grantor of an irrevocable trust retains any power over the trust or the assets, then the value of the trust is included in the grantor’s taxable estate. However, there are provisions that can be included in the trust that allows the grantor to keep the trust flexible.
1. Since 1995, one is the power to remove (and maybe replace) the trustee (Rev Rule 95-68). The grantor can retain the power to fire the trustee.
It is not clear whether the grantor can also then replace the trustee.
- Some attorneys include both the power to remove and replace.
- Others require a majority of the adult beneficiaries to replace the trustee.
- Still others are concerned about retaining the right to remove at all.
That’s where the trust protector comes in. The grantor can not only pick a trustee but also a trust protector who has the power to remove and replace the trustee. The trust protector can have other powers, as well, discussed further below.
2 . Another is the power to protect your descendants after you die.
Holding assets in trust should not send the message that you don’t trust your children. Instead, you should communicate to your heirs that you want their inheritance protected from their creditors, including divorcing spouses and estate taxes.
Most trusts provide for outright distribution after the death of the grantor (or surviving spouse) at specified ages (e.g., one-third at 25, one-half at 30, and the balance at 35).
(Note: Beware of trusts that say equal thirds at ages 25, 30, and 35. Look at the math. If the share is $300,000, then one-third at 25 is $100,000. With no further growth, one-third of the remaining $200,000 at 30 is $66,667, not $100,000. And one-third of the balance ($133,333) is $44,444. That leaves $88,888 still in the trust.)
Instead, consider holding the assets in trust (what we refer to as the “family bank”. For each beneficiary’s share, the trustee has the power to:
- Distribute or loan
- Some, all, or none
- Of the income and/or principal
- To or for the benefit of the beneficiary
This gives the trustee the power to treat your children fairly instead of equally, based on their needs. I am the proud father of three wonderful children. I am very proud to say that I have never treated them equally.
Their needs differ. When I take one child to dinner, I don’t write a check to the other two. When two needed expensive orthodontia, I did not write a check to the third. If one of your children needed expensive surgery, would you ever consider writing a check to the others for that same amount?
You can give the beneficiary the power to remove (and maybe replace) the trustee, but, depending on the beneficiary, you may not want to. That, again, could be a power left to the trust protector and his or her successor.