The Investment Scientist

Mitigate The Risk of Irrevocable Trusts

Posted on: August 17, 2018


irrevocable-trust.pngMany successful families use irrevocable trusts for tax mitigation, wealth transfer and asset protection. In the last few articles, I discussed how an investor with a concentrated highly appreciated position can use a irrevocable charitable remainder trust to diversify concentrated risk, save taxes and benefit a charitable cause.

The caveat with irrevocable trusts is that granting families have to give up a measure of control. The trouble is that many families give up too much control than they need to. The result: they potentially put their goals at risk.

A physician client of mine created a irrevocable life insurance trust (ILIT) years ago to benefit his children. He named his sister, who loved his kids, as sole trustee. Unfortunately over the years, they became estranged and now she does not even return his calls. His trust is effectively in limbo.

What could he have done to avoid this situation?

#1: Retain the power to remove a trustee

Trustees of a irrevocable trust have tremendous power. Whether a trust reaches its intended goal depends largely on the trustees. Therefore it’s important to have a check on their power. A simple trust provision providing that a beneficiary (perhaps a surviving spouse) has the power to remove the trustee for any reason can act as an important control over your trust.

#2: Use an institutional trustee

Most grantors pick a relative or a close friend as trustee. But they may not have the experience, the will, or the persistence to honor your intention at all times while they themselve hardly benefit from it. No wonder situations like my client’s happen over and over again.

The solution is to use an institutional trustee. They usually have a great deal of experience and capability in managing trusts in accordance with the trust documents as well as in keeping good records. After all, that’s how  they earn their keep. Though you usually have to pay them a small fee, you really do your relatives or close friends a big favor by not burdening them with the responsibility of your trust.

If you use an institutional trustee and you give your beneficiaries the power to remove an unperforming trustee, you can mitigate the downside risk of irrevocable trusts.

(Feel free to share if you find it insightful.)

Schedule a Discovery review with me, or get my white paper for free: The Informed Investor: 5 Key Concepts for Financial Success.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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