What is Revocable in an Irrevocable Trust?

With nursing home costs rising and the average life expectancy also increasing, more and more people need to think about how they will afford to age and pass on at least some assets to their loved ones.  One of the most important reasons to consider creating an irrevocable trust is asset protection.  In order to guarantee that creditors and/or Medicaid cannot invade the trust or count the property inside the trust in calculating Medicaid eligibility, the person creating the trust (“settlor”) or that person’s spouse must have absolutely no access to the principal inside the trust.  However, an irrevocable trust can be written so that the settlor can maintain some control over the trustee and the beneficiaries.

To obtain this power, the settlor needs to make sure that the irrevocable trust is written giving a “limited” power to a “donee.”  The settlor can name themselves or their spouse as the donee.  Arizona looks to the Restatement (Second) of Trusts for interpretations of law. A.R.S. §14-10106.  The Second Restatement states that the difference between a limited power of appointment and a general power is that with a limited power, the property subject to the power cannot be appointed to the donee himself, nor to his estate, his creditors, nor the creditors of his estate.  As a matter of common law, and as the Ninth Circuit has maintained, a donee of a limited power is not the owner of the appointive assets. Stern v. C.I.R., 747 F.2d 555, 559 (C.A. 9, 1984).  The donee is, instead, in a fiduciary position with reference to the power but cannot derive a personal benefit from its exercise. Id.

The two powers a settlor generally would like to maintain over an irrevocable trust involve the appointment of the trustee (person overseeing the trust) and the beneficiaries.  In one case, the Arizona Court of Appeals held, if the trust is constructed thusly, the beneficiaries of a trust could be chosen in the donee’s will from a specific list of beneficiaries named in the trust. In re Meyer, 195 Ariz. 336 (Ariz. App., 1999).  Several cases have demonstrated that changing a trustee, so long as another trustee is required to be named concurrently, for any reason or even no reason is a reasonable limited power under a trust. Stern, 747 F.2d at 559; Lafargue v. Commissioner, 689 F.2d 845, 847 (9th Cir.1982); Lazarus v. C.I.R., 513 F.2d 824 (C.A.9, 1975).

However, while constructing the trust, the drafter must be careful not to retain too much power over the trust itself.  At least one court, outside of Arizona and the Ninth Circuit, has ruled that if the settlor transferred property to a trust while retaining a life estate, and the power to change the trustee and beneficiary(ies), the settlor did not intend to place property out of his/her control and, therefore, the transfer was a mere contrivance that was not effective with regard to creditors including Medicaid. First National Bank v. Schwab, 194 So. 307, 309 (1940).

For questions about Irrevocable Trusts or to set up a trust, please contact The Carroll Law Firm at (623)551-9366 and set up a free estate planning consultation.

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