Irrevocable Trusts Explained
Irrevocable trusts are a popular estate planning tool used in New York. An irrevocable trust is a trust that cannot be modified, amended, or terminated (except in very limited circumstances and only by a court order) without the permission of the donor. An irrevocable trust is usually created by a grantor who wants to put some or all of their property out of their reach so that they cannot use the property during their lifetime – meaning the property can’t be sold, given away, gifted, or transferred in any way. However, this does not mean that the property in the trust is unavailable to anyone else. Since the grantor cannot make any changes to an irrevocable trust, it is not under their control. Therefore, a trustee, someone who the grantor designates , has the authority to manage it.
Using an irrevocable trust is a good idea when an individual wants to make sure that their assets are not included in their estate value (for the federal or New York estate tax), so that their estate administration costs are as low as possible, or limited to avoid Medicaid Estate Recovery for the payment of long term care benefits. It is also a good estate planning strategy for minimizing state and federal tax liability.
However, irrevocable trusts are somewhat uncommon because of the irrevocable nature of the grants made into the trust’s corpus. Once assets are placed in an irrevocable trust they cannot be taken back or reallocated. Individuals fear that an irrevocable trust may be unfair to their heirs because the assets are taken out of their ultimate control.
How Trusts Operate Under the Law
Determining a New York Trustee is from New York: The Statutory Framework for Trusts in New York
New York’s Estate, Powers and Trusts Law (EPTL) dictates how a valid trust can be created and what status that trust has after its initial creation. EPTL 7-1.4 ("Creation by Will.") provides that "[u]nless the will provides otherwise, a trust created by will as to the excess of the amount specified in [a former statute, EPTL 17-A] over the exempt amount for such property under the Internal Revenue Code and the regulations thereunder which are applicable to the estate of the decedent shall be considered as having been created by a will, and a trust created by decree shall be considered as having been created by a will or a declaration of trust." EPTL 7-1.4 governs testamentary trusts created by will in New York, but it does not provide definitions for testamentary trusts that are created by other means, such as decree. New York EPTL also governs inter vivos trusts in Article 7 §§ 1-6 entitled "Trusts Created Without Wills." EPTL 7-1.8 provides: (b) A declaration of trust is a declaration made by the owner of any estate or interest in property by which, without consideration and without making a transfer, he directs the trustee to hold or apply the property in trust for the benefit of the owner or of himself and one or more other persons. (c) If a declaration of trust is made by two or more joint owners of the property, it is presumed that the owners intend to create a joint tenancy therein under this sections. The presumption may be rebutted. The death of one or more of the joint owners does not revoke the trust but the declaration is revoked among those joint owners whose declarations upon the property with the unrevoked declarations belong to them alone. (d) A disposition or appointment under the declaration subsequent to the execution thereof shall not be deemed to effect a revocation unless made by a writing containing words of revocation in substance similar to those prescribed by section 7-1.17 of this chapter. (e) Nothing in this article is to be construed as authorizing a person to create a trust for the benefit of himself or another if the statute of wills would prohibit the creation of such trust by will. A Declaration of Trust is defined as "a declaration made by the owner of any estate or interest in property by which . . . he directs the trustee to hold or apply the property in trust for the benefit of the owner or of himself and one or more other persons." EPTL 7-1.8(b). It is a trust that is created by the language of the trust instrument itself and not by deed or will.
What Must Be Contained
The essential elements for executing a trust in New York require the intention of the settlor, the formality of the trust, and a trust agreement.
New York, unlike most other states, does not unequivocally and specifically require a formal document that states, "I hereby create a trust." See our blog post on the topic: Do you need a document to execute a trust? rather, the intention of the settlor is the predominant factor in most cases. Even though the existence of express trusts formed without particular form is permitted under the Estates, Powers and Trusts (EPT) Law, "a trust is created only if the settlor has a definite and specific intent to create a trust." This is the standard we see in a variety of cases such as Anastos v. Karloutsos or in leading cases such as Meinhard v. Salmon.
Despite the wide variety of methods used to express that intention, the law requires the settlor to create a trust or to transfer property to trustees with the intent to create a trust:
(a) by transfer of property to another person as trustee during the settlor’s lifetime or by declaration by the owner of property that he or she holds certain property as a trustee.
(b) by transfer of property to another person whether or not as trustee as security, sales agent, or the like with the intention of vesting in the transferee an estate in trust.
(c) by means of a will making a testamentary disposition of property.
(d) by a disposition of a future interest.
(e) by exercise of a power of appointment to another person as trustee or otherwise.
(f) by tribunal order directing the creation of a trust.
(g) by exercise of a power of appointment in a manner that results in creating a trust.
While a trust may be created by operation of law in some situations, the statute generally requires that creation of a trust must comply very closely with the requirements of a valid private trust. For example, under New York In re Estate of Dunning, the appellate court held that a trust was enforceable because the settlor understood the nature of the business he was conducting and was intoxicated. Therefore, to create a valid trust, Courts have found that certain formalities must be met including that:
- (1) the trust must be funded;
- (2) the settlor must appoint a trustee, and that
- (3) the beneficiary must be ascertainable.
Accordingly, a trust is created when there is a manifestation of an intention to declare the existence of a trust, where there are ascertainable beneficiaries. In addition, the trust must have a definite subject matter, which is whether the trust property can be identified, and that there are valid trust formalities and the intent of the settlor.
Roles of the Trustee and Beneficiary
The terms of the trust will spell out the duties of the trustee and the rights of the beneficiaries. The rights of the beneficiaries are explained below:
"Entitlement to Mandatory Distributions" – this means that a beneficiary is guaranteed to receive distributions during the operation of the trust, often on a periodic basis.
"Entitlement to Discretionary Distributions" – a discretionary distribution means that a beneficiary does not have an absolute right to receive any distributions from the operation of the trust.
"Petition to Compel Trustee" – the beneficiary has the right to petition the Surrogate’s Court to make the trustee fulfill the terms of the agreement. The Surrogate’s Court interprets the trust document and distributes property in accordance with the trust document.
"Right to Judicial Accounting" – a beneficiary has the right to request that the trustee provide a judicial accounting and get an explanation as to what and how the trustee used the funds.
"Right to Have Benefits Accrued" – if a trust is a supplemental needs trust, a beneficiary has the right to accrue the benefits in order to get SSI and Medicaid benefits.
In New York, the following laws affect disbursements of the trust:
An Irrevocable Supplemental Needs Trust (hereinafter "SNT") is subject to review by the Office of Mental Retardation and Developmental Disabilities (hereinafter "OMRDD"). OMRDD may grant a waiver concerning the terms and provisions of an SNT. There are annual reports required concerning the SNT which must include copies of all bank statements, trust administration reports, tax returns and other documents required by the OMRDD.
Notary and Witness Signatures
Trusts must comply with certain formalities in order to be properly executed in New York. N.Y. EPTL § 7-1.17; Matter of Papageorge, 112 A.D.2d 691 (2d Dep’t 1985). These include the "subscribed" (i.e., signed) trust instrument, a notary public acknowledgment for the signature of the Settlor(s) and the Trustee(s), and witnesses, when necessary. If the trust is a testamentary trust, there are additional requirements (e.g., the trust document must be signed by the testator and attesting witnesses): see, e.g., Bankers Life Ins. Co. v. MacKenzie, 15 A.D.3d 462 (1st Dep’t 2004). In this section, we discuss certain execution requirements under New York law specifically for inter vivos trusts. Notarization (i.e., acknowledgments) and witnesses (section does not discuss additional requirements for testamentary trusts, also see Section B.3.6, Witnesses). Acknowledgments. N.Y. EPTL § 7-1.17, provides: "[E]very written instrument to be acknowledged or proved and every other written instrument hereafter executed shall, in addition to the requisites now prescribed by law, be executed and authenticated in the following manner and with the following formalities: 2. a) The act of making an acknowledgment of such instrument must be in the form of a certificate, signed and dated by the person taking the acknowledgment [i.e., the notary public]." (emphasis added) witnesses. N.Y. EPTL § 7-1.17 provides: "[E]very written instrument to be acknowledged or proved and every other written instrument hereafter executed shall , in addition to the requisites now prescribed by law, be executed and authenticated in the following manner and with the following formalities: 2. e) … Any will or a trust created by a writing which takes effect upon death must be subscribed by its maker; but a subsequent subscribing witness shall, on proof of his signature, be competent to prove it, [and] No subscribing witness shall be required to prove the execution of any instrument entitled to be proved by a subsequent subscribing witness." Other formalities. N.Y. EPTL § 7-1.17 provides: "[E]very written instrument to be acknowledged or proved and every other written instrument hereafter executed shall, in addition to the requisites now prescribed by law, be executed and authenticated in the following manner and with the following formalities: 2. b) The term ‘writing,’ when used in relation to this section includes printing, typewriting or reproduction upon any tangible medium of expression, and the word ‘instrument’ is to be construed as if followed by the words ‘whether sealed or unsealed.’" "[I]f one or more signatures are acknowledged by a subscribing witness, the will will be valid even though the other subscribing witnesses do not establish the execution of the will." Arthur v Loring, 243 AD2d 719 (3rd Dept 1997) (internal citations omitted). However, where the trust requires witnessing, the Defective Statute of Wills may apply. EPTL § 3-3.3(2)(c).
Potential Issues with Trusts
Many individuals who create an irrevocable trust run afoul of the rules governing the execution and formalities required for such a dynamic estate planning instrument. The most common challenge we see in our New York trust & estates practice stems from the grantor’s failure to retain a copy of the sole original signed trust instrument. Certain estate administrators for probate proceedings take the cynical position that there can only be one original; the one they handle. After receiving an authenticated copy from the custodian bank or financial institution, they will submit an application for probate to the surrogate’s court of the county in which the decedent died and rely on the fact that Grantor’s failure to retain a copy was a distribution to the county surrogate.
Another common problem we see is that Grantor or the trust maker’s failure to give notice to his children of the creation of the trust. Under Section 7-1.9 of the EPTL, if revocable Trust has been created and if the grantor has had a son, daughter or both after the creation of the trust, then the Trustee shall give the children a copy of the trust instrument as soon as practicable after his death. Given the age of modern advances in technology and the ease of keeping an original signed copy of the trust on a thumb drive, zip disk, old photo disc and the like, grantor of may revoke or modify the trust or revoke the trust altogether as soon as practicable after his death.
Modifying a New York Irrevocable Trust
Once an irrevocable trust has been established it cannot be amended or modified unless the Trust Document, itself, allows for amendment or modification, or unless all parties in interest are willing and able to amend or modify the trust. However, if the beneficiaries and fiduciary wish to change some terms of the trust and they are unable to do so because the trust is irrevocable and the trust terms do not provide for the change, New York law allows parties in interest to petition the court to substitute a new trustee, or to modify or amend the trust.
The court will grant this petition and issue an order amending or modifying the trust to carry out the trustor’s intent in establishing the trust if the court finds that the proposed change is not inconsistent with a material purpose of the trust. A court may also change the terms of the trust if it is in the best interest of the beneficiary. In so doing, a court may permit the addition of provisions which may:
In some cases, the legal alteration of an irrevocable trust requires reformation or decanting. Reformation is a common law remedy that allows a court to rewrite an invalid will or revocable trust in order to comply with the transferor’s intent. It is appropriate where the terms of the writing evidence the grantor’s intent but the document fails because of a mistake of law or fact.
Once a trust is reformed, the trust may be administered according to the modified terms.
Under the decanting statute, a trustee may eliminate or modify the current fiduciary’s powers and authority in favor of another designated person. The trustee may also add individuals who are not currently beneficiaries to the principal as "other persons having a substantial present economic interest." This may provide economic benefits to the trust by incorporating modern investment vehicles. Decanting must meet certain legal requirements in New York. At least 180 days must pass from the date of the original trustee’s notice of first discretionary distribution to the second trustee. The new trustee must be a person that is either named in the decanting trust document, or described in the trust as a "trust protector" or "adviser." The decanting power must be exercised in favor of the same class of beneficiaries of the original trust.
Fortunately, in New York, there are opportunities to modify or amend irrevocable trusts under certain circumstances, if such change is warranted.
Consulting an Attorney on Trusts
While these aspects of the execution of an irrevocable trust in New York may be engaging and interesting to a lawyer interested in the nuances of such an event, they are of little or no interest to the non-lawyer. Even more to the point, the type of errors and omissions that can occur in executing an irrevocable trust properly in New York, and the attendant types of litigation that can occur as a result of such errors, make it essential for a lay person to have their trust drafting and executing processes reviewed by a lawyer. When trust planners are involved, the advantages of their experience can sometimes ameliorate the effects of mistakes made in the process of executing an irrevocable trust. In addition to simple oversight issues , the trust planner must always be on guard against the possibility of a trust execution that fails to deviate materially from the general rules of New York – and these can be hard to catch if the client insists upon or is insistent about using their own language in the trust document. In such cases, it is critical to have a lawyer involved in order to protect against the possibility of a claim against a trustee or beneficiary based on improper drafting or execution of the agreement itself. For a lay person, the best course of action would be to consult with a trust and estate lawyer at the planning stage, hopefully prior to or during drafting, so as to help avoid problems at the execution stage.