An irrevocable trust is a popular estate planning tool used to minimize taxes and protect assets from creditors. But how exactly does an irrevocable trust work and what are the key features to understand? This comprehensive guide examines irrevocable trusts in detail to help you determine if this type of trust meets your needs.
What is an Irrevocable Trust?
An irrevocable trust is a type of trust that cannot be altered, amended, or revoked once it has been created. The person who establishes and transfers assets into the irrevocable trust is called the grantor. The beneficiaries are the individual or organizations that will profit from the trust.
Once an irrevocable trust is set up and the grantor transfers assets to the trust, they forfeit all control and legal ownership over those assets. An appointed trustee assumes full control over managing the irrevocable trust and its assets for the benefit of the beneficiaries.
Unlike revocable trusts that allow the grantor to modify terms and even dissolve a trust while alive, irrevocable trusts cannot be changed or reversed easily. The only way to make alterations is with the beneficiary’s consent or by court order, which are rare circumstances. As a result, irrevocable trusts are viewed as permanent and binding legal instruments.
How Does an Irrevocable Trust Work?
Here is a high-level overview of how assets flow through an irrevocable trust:
- The grantor first works with an estate planning attorney to draft an irrevocable trust document that details the terms and conditions for asset management and distribution.
- Selected assets are retitled in the name of the irrevocable trust so that ownership is transferred on paper. Typical assets can include cash, life insurance, real estate, business interests, and investments.
- The grantor names a trustee to oversee the irrevocable trust and manage the assets according to the trust document terms. The trustee can be an individual (non-family member) or a corporate trustee like a bank or trust company.
- The irrevocable trust document identifies the beneficiaries who will receive trust benefits. Distributions of income and/or principal from the trust assets are made either ongoing or at a defined time in the future.
- The grantor cannot control the trustee’s decisions or make changes to the irrevocable trust once executed. Modifications require beneficiary approval or a court ruling.
- Upon the grantor’s death, the irrevocable trust assets pass directly to beneficiaries per the trust terms. These assets are not subject to probate.
The key distinction of an irrevocable trust is the lack of control held by the grantor once assets are transferred into the trust. The grantor cannot simply revoke the trust and regain ownership of the assets.
Types of Irrevocable Trusts
There are two main types of irrevocable trusts:
Living Trusts
A living trust, also called an inter vivos trust, is created and funded during the grantor’s lifetime. Some examples include:
- Irrevocable life insurance trusts (ILITs) – Used to own life insurance policies outside of the grantor’s taxable estate.
- Charitable remainder trusts – Provides income to the grantor with remaining assets donated to charity upon death.
- Charitable lead trusts – Provides income to charity with remaining assets transferred to beneficiaries.
- Asset protection trusts – Protects assets from creditors and lawsuits.
Testamentary Trusts
A testamentary trust is created through instructions in the grantor’s will and funded upon death with assets from the estate. Since it does not take effect until after death, changes can be made by simply revising the will.
Key Benefits of Irrevocable Trusts
The most common reasons to use an irrevocable trust include:
- Minimizing estate taxes – When the grantor passes away, assets deposited in an irrevocable trust are exempt from estate taxes. This can save thousands in taxes for high-net-worth individuals.
- Asset protection – Assets transferred to an irrevocable trust are shielded from creditors and lawsuits per Minnesota spendthrift provisions.
- Probate avoidance – When a beneficiary passes away, assets held in an irrevocable trust transfer to them immediately, saving time and money on the probate process.
- Government benefit eligibility – Irrevocable trusts can help individuals qualify for means-tested government benefits like Medicaid.
- Management of assets – The trustee oversees trust assets on behalf of beneficiaries who may be minors or have special needs.
How to Create an Irrevocable Trust
While irrevocable trusts offer benefits, they require careful drafting. Consider the following steps:
- Consult with a trust lawyer to evaluate your goals and options. There are costs involved with creating and maintaining trusts.
- Choose a trustee to manage the trust assets. Consider their capabilities, fee structure, and potential conflicts of interest.
- Name trust beneficiaries. Balance current and future needs especially with long-term trusts.
- Determine what assets to transfer into the trust. Non-protected assets with potential growth are ideal candidates.
- Develop personalized trust terms that align with your intentions. Flexibility provisions can help address unforeseen circumstances.
- Fund the trust by formally transferring ownership of assets. Some assets may require re-titling.
- File a gift tax return for transfers over the annual exclusion amount to start the clock on the statute of limitations.
Proper creation of an irrevocable trust requires coordination with your financial advisor and CPA. An estate planning attorney can navigate the specifics based on your situation.
Irrevocable Trusts vs. Revocable Trusts
Should you consider a revocable trust instead of an irrevocable trust? Here is a brief comparison:
- Control – Revocable trusts allow the grantor to modify terms and revoke the trust. Irrevocable trusts cannot be changed or revoked.
- Taxes & Creditors – Irrevocable trusts provide estate tax savings and asset protection that revocable trusts do not.
- Probate – Both trusts avoid probate if funded properly.
- Disclosures – A revocable trust does not need to be disclosed when applying for Medicaid or other public benefit programs. An irrevocable trust must be disclosed.
For most individuals, there is a place for both irrevocable and revocable trusts as part of a comprehensive estate plan. They should not be an either/or proposition. As always, speak to an attorney about integrating both types of trusts into your specific situation.
Is an Irrevocable Trust Right for You?
As you can see, irrevocable trusts offer powerful benefits but require thoughtful implementation. Consider the following questions to determine if this type of trust is appropriate:
- Do you have assets in excess of $12 million that may incur estate taxes? Irrevocable trusts can help minimize this tax liability.
- Do you want long-term protection from creditors or judgment for a specific pool of assets? The protections of an irrevocable trust may provide peace of mind.
- Are you concerned about providing assets to beneficiaries who may misuse lump sum inheritances? An irrevocable trust allows you to control distributions.
- Do you want your estate to remain private versus going through probate? Assets in an irrevocable trust remain private and avoid probate.
- Are you planning to qualify for long-term care Medicaid in the next 5 years? An irrevocable trust may impact your eligibility.
If you answered yes to any of these questions, consulting a St. Paul estate planning attorney at Safe Harbor Estate Law in Minnesota for irrevocable trust advice can ensure it meets your financial goals and estate planning needs.
