Should I Set Up an Irrevocable Trust for My Estate?

Irrevocable trusts have many benefits and limitations. Learn more about whether an irrevocable trust works for you.
Tiffany Lam-Balfour
By Tiffany Lam-Balfour 
Edited by Chris Hutchison

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Irrevocable trusts are one of two main types of trust. Like its counterpart, a revocable or living trust, an irrevocable trust can help you avoid the often time-consuming and costly probate process, 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 estate reduction and asset protection. These benefits can be compelling enough to overcome more onerous requirements, such as giving up control of your assets and getting a handle on more complicated trust strategies.

What is an irrevocable trust?

An irrevocable trust is a trust that cannot be changed or revoked by the creator, known as the grantor. Though exceptions can be made at times, there’s no easy workaround since either all beneficiaries of the trust must agree to the change, or there needs to be a court decree.

The grantor transfers assets into the trust and designates a third party to act as trustee. Once assets are moved into the irrevocable trust, the grantor surrenders any and all ownership rights and cedes control to the trustee. These assets are removed from the grantor’s taxable estate.

Do you need an irrevocable trust?

Most financial decisions boil down to what your specific situation looks like and what end goals you’re trying to reach. However, there are a handful of instances when an irrevocable trust could be a fitting solution for you.

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1. When you want a shield from estate taxes

If you have a large estate likely to be subject to estate tax, figuring out ways to minimize or avoid the hefty tax burden can be enticing. The 2022 estate tax exemption is $12.06 million for an individual or $24.12 million for a married couple. Estates exceeding these limits will be subject to federal estate tax of up to 40% depending upon the taxable amount. On top of that, some states levy their own estate taxes.

Given that the exemption limit is high, only a subset of people will need to worry about it. However, the federal estate tax exemption could change or become lower over time, which is something to consider when planning for the future.

For estates that exceed the limit, there are various strategies to examine. Some might purchase life insurance as a way to replenish assets paid to the IRS, while others might explore alternative means to shelter their estate from taxes. Enter the bevy of irrevocable trusts.

There are credit shelter trusts that allow married couples to leave assets behind to their spouse and children without triggering estate taxes. Credit shelter trusts include AB trusts; qualified terminable interest property trusts, or QTIPs; and qualified domestic trusts, or QDOTs.

When it comes to gifting, there are many trust strategies that allow you to transfer assets to heirs with little or no estate tax, such as grantor-retained annuity trusts, or GRATs, and qualified personal residence trusts, or QPRTs. There are ways to shelter children from estate tax using generation-skipping trusts, or even multiple generations of heirs with dynasty trusts. Spendthrift trusts can provide for heirs lacking in responsible money habits, and special needs trusts can look after those who need assistance due to disability.

If you are charitable, gifting assets can offer a win-win solution — the charity gains from donated assets, while the grantor can collect a tax break. There are many charitable gifting trust strategies, including charitable remainder trusts, or CRTs; charitable lead trusts, or CLTs; and pooled income trusts.

2. When you need to protect assets from creditors

Similar to how an irrevocable trust eliminates estate taxes because trust assets are no longer part of the grantor’s estate, irrevocable trusts can also safeguard assets from creditors. Again, the trust assets are no longer owned or controlled by the grantor.

For those in occupations that are more prone to being sued or dealing with lawsuits — such as attorneys, doctors and real estate developers — finding a way to keep your 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.

3. To qualify for certain government programs

Using a trust isn’t only for those with large estates. To qualify for certain government programs, applicants often need to demonstrate limited assets and income in their personal estate.

An asset protection trust can help remove assets from one’s estate to gain eligibility for government programs. For example, long-term care costs are not generally covered by Medicare. But long-term care is covered under Medicaid, the government’s health care program for lower-income Americans.

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. An asset protection trust formed within that time frame will likely result in a violation of the look-back rule and induce a period of ineligibility for the applicant.

An elder law attorney can help shed more light on whether a Medicaid asset protection trust is a feasible solution for you.

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Relinquishing control of your 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, or 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.

Irrevocable trusts limit the flexibility of the grantor. Once trust assets are transferred, 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.

Understanding complex strategies

Another downside of irrevocable trusts is that many trust strategies are complex and 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 since they 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.

» Irrevocable trusts not right for you? Consider a living trust instead

Even if these strategies are confusing, all is not lost. An estate planning attorney can work together with your tax and financial advisors to help determine what works best for your situation and assist you in achieving your estate planning goals.

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