From the word alone, “irrevocable” connotes something permanent, unchangeable and irreversible. This would seem to imply that irrevocable trusts are all of those things.
But realistically speaking, nothing is permanent, and even irrevocable trusts are often designed with an end point in mind. The use of the word “irrevocable” is used mostly to convey the fact that the terms of an irrevocable trust instrument cannot be changed or amended – as opposed to a revocable trust that offers exactly that.
So irrevocable trusts, once set up, are to operate according to the foundational trust instruments, with no possibility of amendment, alteration or even termination – other than termination contemplated by or according to the terms of the trust itself.
If you are wondering why anyone would set up a trust that they can no longer amend or change, and then transfer their own property to the trust so that they effectively lose any control over those properties – there are benefits.
Irrevocable trusts are often utilized for a number of reasons, including asset protection, tax reasons, probate avoidance, and long-term care planning, among others.
In this article we take a look at the various reasons for closing an irrevocable trust, in order to provide a broader context to how to close an irrevocable trust.
When Death Triggers a “Winding Up”
Some irrevocable trusts are designed to terminate upon the death of the settlor. The intention, at this point, is generally the distribution of assets upon the grantor’s death, from the trust.
Under these circumstances, the closing of the trust does not take place automatically. There is a period of administration and winding up for a trust. This phase may, when seen from a certain perspective, actually resemble probate proceedings in many ways. The primary difference, of course, is that winding up an irrevocable trust starts and ends outside of probate.
During this brief period of administration after the grantor’s death, the trustee becomes like a temporary custodian tasked with performing certain duties within a reasonable time.
These duties may include:
- Paying any valid debts, funeral expenses, medical bills, and other administrative costs;
- Filing income tax returns and settling any estate transfer taxes;
- Comply with Probate Code §16061.7 by serving a formal Notice of Irrevocability upon the beneficiaries of the trust and the heirs of the grantor. Note that this notice requirement triggers a 120-day window within which beneficiaries may contest the trust.
Many trustees elect to delay final transfer and distribution of the trust assets until this 120-day window expires and any contests brought within this period are resolved, and the trust closed.
Fulfillment of Material Purpose
Some irrevocable trusts are intended to continue long after the death of the grantor. The trust instrument would indicate the material purpose that the trust was designed to fulfill, and any instructions for trust activities in the meantime would also be indicated.
Perhaps one of the clearest example of this type of trust is an irrevocable trust intended to provide for a minor dependent until they reach a certain age. For instance, a trust established for the benefit of a minor child, providing daily living costs, health care and educational costs, up until the child reaches a specified age threshold (e.g., 25 years of age).
When the minor beneficiary of the trust reaches their 25th birthday, the material purpose of the living trust has been fulfilled.
Conversely, should the minor beneficiary pass away, the purpose of the trust becomes futile. A well-prepared trust anticipates even this possibility, and the trust instrument would indicate how the trust assets are to be distributed.
Either way, the trustee then has the responsibility to comply with all applicable legal and statutory final requirements for the closing of the trust, until final distribution of the trust assets to the beneficiaries.
Statutory Termination of an Irrevocable Trust
Sometimes, a trust may not exist long enough to fulfil its purpose.
Sometimes, a trust is closed under the law when its assets are not enough to allow it to fulfil its stated purpose.
Under Probate Code §15408, a trust may be terminated if “the fair market value of the principal of a trust has become so low in relation to the cost of administration that continuation of the trust under its existing terms will defeat or substantially impair the accomplishment of its purposes.”
This means that if the cost of maintaining and administering the trust eats up so much of the trust assets, rather than going towards the benefit of the trust beneficiaries, then it may be counterintuitive to have a trust in the first place.
The Closing of a Trust
Regardless of the trigger or the reason for the closing or the termination of a trust, it is the responsibility of the trustee to ensure that the process of closing the trust is efficient, transparent, and final. Doing so prevents needless costs, preserve assets, and protects both the beneficiary and the trust assets from liability.
The final steps would include the distribution of the trust assets. Some trustees, in order to further shield themselves from risk, may also obtain receipts from the beneficiaries, as well as signed releases that discharges them finally from any further liability.
Is your trust reaching its natural conclusion? Do you need assistance in formulating the strategy for your trust, including its termination? An estate planning attorney can help you finalize your trust documents, as well as ensure the efficient closing of your trust under California law.