Distributing Assets from an Irrevocable Trust: A Guide for Trustees and Beneficiaries

If you have been named as a beneficiary of an irrevocable trust, you may be wondering when you will receive your share of the trust assets. As a trustee, you may be wondering how to properly distribute the assets in an irrevocable trust to the beneficiaries. 

Distributing assets from an irrevocable trust can seem complicated, but having a basic understanding of the process will help beneficiaries know what to expect and will help trustees carry out their duties appropriately.

What is an Irrevocable Trust?

Before diving into the distribution process, it helps to understand what an irrevocable trust is. An irrevocable trust is a trust that cannot be changed or revoked once it has been set up. The grantor transfers assets into the trust, names the beneficiaries, and gives up all control over the assets.

An irrevocable trust has a number of benefits:

  • Asset protection – Assets are protected from creditors and lawsuits once transferred into the trust.
  • Tax planning – Certain types of irrevocable trusts can help minimize estate taxes when assets pass to beneficiaries.
  • Probate avoidance – Assets in an irrevocable trust do not need to go through probate when the grantor passes away.
  • Control over distributions – The trust document controls when and how assets will be distributed.

Common types of irrevocable trusts include intentionally defective grantor trusts (IDGTs), irrevocable life insurance trusts (ILITs), and charitable remainder trusts (CRTs).

What Types of Irrevocable Trusts Exist, and How Do They Affect Distribution?

Several types of irrevocable trusts can be used for different purposes in estate planning. A special needs trust, for instance, is designed to provide for a beneficiary with special needs without jeopardizing their eligibility for government benefits. A family trust is often used to transfer wealth to future generations while preserving family assets. The type of irrevocable trust used can significantly impact the distribution method, the way beneficiaries get money, and the rules for trust fund distribution to beneficiaries.

When Do Irrevocable Trust Assets Get Distributed?

The timing of distributions from an irrevocable trust depends on the terms outlined in the trust document, which is a legally binding contract. Here are some common distribution scenarios:

  • Scheduled distributions – The trust may provide for distributions at certain ages (e.g., 1/3 of assets at age 25, 1/2 of remaining assets at age 30, and balance at age 35).
  • Health, education, maintenance, and support – The trustee can make discretionary distributions for these purposes, even if the beneficiary is a minor.
  • Discretionary distributions – The trustee has discretion over when and how much to distribute based on the needs of the beneficiary and the purposes of the trust.
  • Mandatory distributions – Trust requires certain distributions on fixed dates or upon the occurrence of specified events.
  • Upon termination of trust – Assets distributed when the trust terminates at a set date or upon a certain event (e.g., death of beneficiary).

Trust assets cannot be distributed until all debts and taxes are paid. The trustee will need to file a final tax return and pay any taxes owed before making distributions.

Can a Trustee Withhold Distributions?

Generally, a trustee should follow the distribution instructions outlined in the trust document. However, most states allow a trustee to withhold or delay distributions in certain circumstances, such as:

  • The beneficiary is a minor (distributions can be delayed until the age of maturity).
  • The beneficiary has special needs that must be addressed before distributions are made.
  • The beneficiary is deemed incapable of managing the money responsibly.
  • Some outstanding debts or taxes must be paid before making distributions.
  • A beneficiary contests the trust or disputes distributions.
  • The terms of the trust give the trustee discretion over distributions.

Reasons for withholding must align with the purpose of the trust and the best interest of beneficiaries. Withholding without valid reasons could prompt legal action by beneficiaries.

How are Assets Transferred from an Irrevocable Trust?

To distribute assets, the trustee must follow the proper transfer procedures for each type of asset:

  • Cash – The trustee can write a check or wire transfer funds to the beneficiary’s bank account.
  • Stocks and bonds – Securities can be re-registered into the beneficiary’s name or brokerage account.
  • Real estate – The trustee will prepare a new deed transferring ownership from the trust to the individual beneficiary. The deed must be recorded.
  • Business interests – Ownership shares can be transferred via business transfer documents and reissued under the beneficiary’s name.
  • Personal property – The trustee can create a bill of sale listing items and their value, which the beneficiary signs upon transfer.

All distributions must be properly documented for accounting purposes. Receipts of distribution acknowledge assets received.

What Are a Trustee’s Responsibilities During Distributions?

The trustee has important legal and tax obligations during the distribution process:

  • Inventory assets – Trustees must document all assets, values, income, expenses, distributions, and fees annually.
  • Pay debts and expenses – All legitimate debts, taxes, and trust expenses must be paid before distributions.
  • Create accounting – A detailed accounting of all trust transactions must be provided to beneficiaries annually.
  • File income tax returns – The trust must file annual income tax returns and pay applicable taxes.
  • Obtain beneficiary information – The trustee will need each beneficiary’s name, address, SSN, and account information to report distributions.
  • Issue tax forms – Forms K-1 show each beneficiary’s share of trust income, deductions, and credits for the tax year. Form 1041 is filed for the trust.
  • Follow trust terms – Carry out distributions according to the trust terms unless valid reasons exist to delay or withhold distributions.
  • Be impartial – Treat all beneficiaries impartially according to their relative interests in the trust.
  • Invest prudently – Manage the trust assets in a prudent manner.

Non-compliance with these duties exposes the trustee to potential removal or surcharge lawsuits from unhappy beneficiaries.

Can Beneficiaries Dispute Distributions from a Trust?

Yes, beneficiaries can dispute distributions if trustees do not follow the terms of the trust or carry out their legal duties properly. Reasons for disputes include:

  • Improper distributions – Assets were distributed incorrectly or to the wrong beneficiaries.
  • Missed distributions – Required distributions were not made.
  • Premature distributions – Assets distributed earlier than allowed.
  • Delayed distributions – The trustee is improperly withholding required distributions.
  • Inadequate accounting – Beneficiaries were not provided with a proper trust accounting.
  • Mismanagement – Trust assets have been depleted due to trustee mismanagement or theft.

Beneficiaries should consult an estate planning attorney if they wish to contest distributions or take action against a trustee. The court can review the trustee’s actions, compel distributions, order accountings, or even remove the trustee entirely if sufficient evidence of misconduct exists.

Can a Beneficiary Reject Distributions From a Trust?

Beneficiaries can choose to disclaim or refuse a distribution from an irrevocable trust. Reasons may include tax implications, wanting assets to pass to other beneficiaries, or not wanting the hassle of managing assets.

To validly disclaim a distribution, the beneficiary must:

  • Make the disclaimer in writing before accepting any distribution.
  • Deliver the disclaimer to the trustee within 9 months of the creation of the interest or event triggering the distribution.
  • Not have received any benefit from the disclaimed interest.

A properly disclaimed distribution will pass to the next named beneficiary in line. Refusing distributions can have tax and legal consequences, so professional tax/legal guidance from an experienced estate planning law firm like Vollrath Law is advisable before disclaiming.

Do Trust Funds Pay Out After Death?

In many cases, trust funds do pay out after the death of the grantor. The specific distribution of trust funds after death depends on the terms of the trust. Some trusts may distribute all assets immediately upon the grantor’s death, while others may continue to operate, distributing income and principal to the beneficiaries over time. The trustee is responsible for trust administration after the grantor’s death, including distributing the assets as directed by the trust document.

Consult an Attorney for Trust Distributions

Distributing assets from an irrevocable trust involves important legal and tax considerations. Beneficiaries should understand their rights and interests in the trust. Trustees need to know their legal duties and proper procedures. Consult an experienced estate planning or trust litigation attorney from Vollrath Law in Oviedo, FL, who can help avoid disputes and liability risks during distribution.