Irrevocable Trust: What It Is, How It Works, Uses
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What is an irrevocable trust?
An irrevocable trust is a trust the creator (called the grantor) cannot change or revoke. Creators give up control of the assets they put into irrevocable trusts. For this reason, an irrevocable trust can reduce estate taxes. It can also help avoid the probate process upon death.
Like its counterpart, a revocable or living trust, an irrevocable trust can allow you to make arrangements ahead of time in case of incapacity and generally keep your financial affairs private.
Irrevocable trusts can provide some other perks, such as asset protection. These benefits can be compelling enough to overcome more burdensome requirements, such as giving up control of your assets and getting a handle on more complicated trust strategies.
» Learn more: See the difference between revocable and irrevocable trusts
Can you withdraw money from an irrevocable trust?
Though there are exceptions, there’s no easy workaround once assets are in an irrevocable trust. Either all beneficiaries of the trust must agree to the change, or there needs to be a court decree.
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How to set up an irrevocable trust
The grantor establishes the trust.
The grantor designates a third party to act as trustee and names beneficiaries.
The grantor transfers assets into the trust. The grantor surrenders ownership rights and cedes control to the trustee. These assets are no longer part of the grantor’s taxable estate.
Types of irrevocable trusts
There are many kinds of irrevocable trusts. Below are some examples. An estate planning attorney can consult with your tax and financial advisors to help determine what works best for your situation and help you meet your estate planning goals.
Grantor-retained annuity trusts (GRATs) and qualified personal residence trusts, or QPRTs. A GRAT is an irrevocable trust that allows the grantor to put certain assets in a temporary trust and freeze its value, removing additional appreciation from the grantor’s estate and giving it to heirs with minimal estate or gift tax liability. During the term of the GRAT, the trust pays an annuity to the grantor, so the assets in the GRAT are considered returned to the grantor.
Generation-skipping trusts and dynasty trusts. These can shelter children or even multiple generations of heirs from estate tax. In a generation-skipping trust, for example, you transfer money to grandchildren or other people who are at least 37.5 years younger than you.
Spendthrift trusts. When beneficiaries can’t make good financial decisions for themselves, the trustee decides how the beneficiary is allowed to use the money.
Special needs trusts. Also known as supplemental needs trusts, these allow a person with functional needs to get financial support without negatively affecting any means-tested government benefits they’re receiving, such as like Medicaid or Supplemental Security Income (SSI).
Charitable remainder trusts (CRTs), charitable lead trusts (CLTs) and pooled income trusts. These essentially leave any leftover trust assets to a charity of the grantor's choice.
» MORE: Learn what a bequest is
Benefits of an irrevocable trust
Irrevocable trusts have some notable advantages.
1. Potential estate tax savings
The federal estate tax ranges from rates of 18% to 40% and generally only applies to assets over $12.06 million in 2022 or $12.92 million in 2023. On top of that, some states levy their own estate taxes.
If your estate is likely subject to estate tax, figuring out ways to minimize or avoid the hefty tax burden can be enticing. However, the federal estate tax exemption could change or become lower over time, which is something to consider when planning for the future.
2. Protection from creditors
For those in occupations prone to lawsuits — such as attorneys, doctors and real estate developers — keeping personal assets out of the reach of creditors can help protect you and your heirs. Asset protection trusts do exactly this.
There are two varieties: domestic and foreign or offshore. Not all states allow domestic asset protection trusts, and foreign ones can be costly to administer. Furthermore, if a court determines that your asset protection trust was created with the intent to defraud creditors, you could face significant legal consequences and be forced to undo your asset transfer.
» Need some help? Check out our roundup of the best wealth advisors
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3. Qualification for certain government programs
To qualify for certain government programs, such as Medicaid, applicants often need to demonstrate that they have limited assets and income.
An asset protection trust removes assets from one’s estate, which can in turn make a person eligible for certain government programs. For example, Medicare generally does not cover long-term care costs, but Medicaid, the government’s health care program for lower-income Americans, does.
Note that there are many rules surrounding the use of asset protection trusts to reduce assets. Medicaid has a "look-back" period of up to five years to check that no assets were given away during that time. Forming an asset-protection trust within that time frame may violate the look-back rule and induce a period of ineligibility for the applicant. An estate planning attorney can help shed more light on whether a Medicaid asset protection trust is feasible for you.
Disadvantages of irrevocable trusts
1. Loss of control over assets
No matter what reasons are prompting you to set up an irrevocable trust, you’ll need to get comfortable giving up ownership rights and control of your assets. It isn’t always easy to let go of assets you’ve worked hard to earn and accumulate over your lifetime.
2. Reliance on a trustee
It may be hard to find someone you’re aligned with and feel confident will make decisions in the best interest of the trust. Grantors can usually appoint a trust protector as an additional set of eyes to watch over the management of the trust. Trust protectors pay attention to regulations and laws to monitor if any changes will have an adverse impact on the trust. They can act as a mediator if beneficiaries disagree and can also replace the trustee if necessary. The grantor is able to prescribe what powers the trust protector has when drafting the trust document.
3. No beneficiary changes
Once trust assets are transferred into an irrevocable trust, the grantor cannot alter the terms of the trust. This means that the grantor cannot remove or change the beneficiaries named in the trust or regain control of any trust assets if fortunes change and those assets are needed down the road.
4. Complexity
Trust strategies are complex and can be hard to understand and administer. Hiring an expert carries a cost as well, though it could be a drop in the bucket compared to the long-term benefits of the trust. But because your decisions are irrevocable, making sure you’re aware of all the details and corresponding implications is very important so that you don’t end up inadvertently doing something you wouldn’t have wanted to do.
» Crafting a trust or will yourself? Here are our top picks for online will makers
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