Irrevocable Trusts: More Revocable Than You Might Think

We’re working on one right now: In 1980, a man created a trust for his daughter. When she dies, the beneficiaries will be her children.

We’ve realized that the trust has a great deal of low-basis stock in it. So a lot of capital gains have occurred over 40 years. Almost $2 million of appreciated assets are in this trust, and you can’t take advantage of the step-up in basis with the current arrangement.

So we got everybody’s agreement to amend the trust to give the daughter, who is in her 70s, a general power of appointment.

For generation-skipping transfer-tax purposes, that makes her the transferor instead of her dad, who died in 1981.

Further, at her death, it allows those assets to take advantage of the step-up in basis.

As a result, when she dies, the family is going to save $400,000 in taxes, which would have been the capital gains tax on $2 million.

When it comes to financial planning, how else can irrevocable trusts be useful?

There’s a method of pouring one trust into another, or decanting. A friend of mine calls that “diffusing disaster.”

It’s a trust law concept used to settle a dispute, which has developed widely in recent years. 

Let’s say some provision in a trust is ambiguous, and one side of the family is fighting the other about it.

The trustee can decant, or distribute, all the assets of the trust into a new trust without getting the court involved. Therefore, it’s not an expensive thing to do.

With all this flexibility to change an irrevocable trust, why would someone establish one? Why not just set up a revocable trust instead?

The big reason is coming up in two years.

For people that have a combined net worth of $1 million or a couple of million dollars, it’s not an issue. It concerns couples with $15 million and up. 

Advisors should talk with such clients about this — the sooner, the better — and bring in an attorney.

What’s coming up, then?

The “estate tax cliff”: A tax law that Mr. [Donald] Trump’s administration passed sunsets in 2025. This means that the applicable exclusion amount, which for 2024 is $13.61 million, will drop to the amount it was back in 2012, which was $5 million indexed for inflation.

Most experts think it’s going to be about $7 million per person.

So the ability to transfer wealth — $14 million per person, $28 million per couple — will be effectively cut in half.

That’s where these fancy irrevocable trusts come in because they can leverage the exclusion amount.

How?

If you have a concentration of low-basis assets, you might want to use a charitable remainder trust to leverage the gifts that you make to your loved ones. 

Or if a large part of your wealth is in the form of a personal residence or vacation residence, you might want to create a qualified personal residence trust.

This is an irrevocable trust that holds just the real estate, and you retain the right to live there rent free for a term of years and the right to have it come back into your estate if you die during that term.

So because the rule sunsets in 2025, speed is of the essence. Isn’t it?

Right now, we’re in a use-it-or-lose-it scenario. 

Broadly, the country’s big wealth transfer, especially for baby boomers, has begun. In light of that, what should the generation who holds the assets be doing?

They need to plan and get in to see their attorneys to make sure their wealth is being transferred as effectively as possible.

Once you get past the basic questions of estate planning: Who do you love? What do you have? Where do you want it to go? Estate planning is a tax game, as the federal transfer tax system has been called.