Many people can benefit from using trusts in their financial planning. They are powerful tools and can help make sure the grantor’s wishes are carried out. Most commonly, people can use a revocable trust to avoid probate costs.
Irrevocable trusts tend to be utilized primarily by the more affluent, with some notable exceptions. In an irrevocable trust, the grantor gives up all ownership rights. This can be useful in several situations.
Primary Uses of Irrevocable Trusts
The greatest benefit from irrevocable trust is that trust assets are not part of the grantor’s taxable estate. While federal estate taxes are not a burden for most people, many states tax at lower levels.
Assets put into an irrevocable trust during the grantor’s lifetime are not owned by the grantor at time of death and are not includable for estate tax purposes.
There are several forms of trust that can be used to accomplish this goal, depending on the grantor’s specific needs.
One common way to utilize an irrevocable trust is to put appreciable assets the grantor will not need during their lifetime into a trust to pass the assets to the beneficiaries without estate tax depletion.
Similarly, an irrevocable life insurance trust can be used to own a life policy on the grantor while keeping the death benefit outside of the estate for tax purposes.
Some professions are prone to lawsuits, notably medical doctors, and some others. An irrevocable trust insulates the assets from lawsuits. Many states require at least a period of a couple of years after the transfer of assets into the trust before they are shielded from creditors. It’s not a last-minute move.
One benefit of irrevocable trusts that can apply to people of less lofty means is shielding assets to qualify for government benefits. An irrevocable trust can be used to keep the assets owned by the grantor below the threshold to qualify for Medicaid or other government benefits.
This can be useful in planning for a potential nursing home stay. This is also a move that must be made well in advance of the need.
Similarly, an irrevocable trust can be used to keep the assets and income of a special needs beneficiary at a level where they remain qualified for government benefits while still providing for some of their needs.
Parties to an Irrevocable Trust
Every irrevocable trust needs three parties. There must be a grantor, a trustee, and a beneficiary or beneficiaries.
The grantor is the creator of the trust and provides the funding. The trust can be set up to begin during the grantor’s life, which is known as an inter vivos trust. An inter vivos trust can be either revocable or irrevocable; the irrevocable form is our interest here.
A trust can be created upon the grantor’s death. This is a testamentary trust and can only be an irrevocable trust. Naturally, the grantor could not make changes after the trust is established as they are no longer living.
The trustee manages the trust assets and files any appropriate tax returns. The trustee works for the trust and in the interest of the beneficiary or beneficiaries.
The grantor cannot be the trustee. In most cases, the trustee cannot be related to the beneficiaries.
The beneficiary or beneficiaries are the ultimate recipients of the trust assets. The trust specifies the conditions upon which the beneficiaries receive the assets.
Often the triggering event is the death of the grantor. Sometimes the grantor establishes different criteria, such as providing a portion of the assets at different intervals, either by time after the grantor’s death or by age of the beneficiary. This can be useful if the grantor is concerned about the beneficiary’s ability to manage a larger sum of money.
Eligible Trust Assets
This is open. An irrevocable trust can own cash, investment assets, real estate, business entities, or life insurance, as well as some others.
Assets you would want to be able to get out of your estate for tax purposes or to remove income to qualify for government programs can be put into the trust. The assets you put into the trust would depend on your specific needs and objectives.
Drawbacks of Irrevocable Trusts
When we look for the drawbacks of an irrevocable trust, there is a big one right there out front: They’re irrevocable. If your situation changes, it's too bad.
You cannot change the trust because the rules changed or because your situation changed. You cannot take back the assets because you need them now. They are no longer your assets; you gave up all ownership rights when you put the assets into the trust.
This cannot be overstated. You should never be putting assets you may need to spend into something where you no longer own them.
You may find the trustee does not do what you want. They are not supposed to do what you want; they are supposed to act in the best interest of the beneficiary or beneficiaries.
You cannot be a beneficiary of your own irrevocable trust and the trustee can be sympathetic to your situation but needs to act first for the person or persons for whom the trust was created, and that is the beneficiary.
They’re pricey. Estate planning is complex and should be done by qualified professionals. You can get by with some standard form revocable trusts in some situations.
For an irrevocable trust, your specific circumstances and needs must be addressed and you should have a competent estate attorney and plan on spending at least a few grand for a basic trust. The trust may need to hire a trustee, which is a cost to the trust.
The Bottom Line
Irrevocable trusts can be powerful tools. They are particularly useful for estate planning for larger estates. They can help with charitable giving strategies and help insulate assets from creditors.
The benefits come at a cost.
They are complex vehicles, and their use often requires giving up ownership of the assets you wish to protect or transfer, depriving you of their future enjoyment.
And you can’t take that back. If you have the specific needs and resources to benefit from an irrevocable trust, you should seek the counsel of a knowledgeable estate attorney. This is a specialized area of law and should be entrusted only to those amply qualified and experienced.