Most people think that trust accounts are only for the super-wealthy. That is not always the case, as trusts can provide many benefits even to individuals of average financial status.
Before establishing a trust, you should learn the basics of trusts and when to use them.
There are different categories of trusts, each with pros and cons. In this article, we will examine irrevocable trusts in more detail. Even within irrevocable trusts, there are many types, each with a fairly specific use.
Keep reading to learn more about the different types, setup costs, benefits, etc.
What Is An Irrevocable Trust?
As the name implies, an irrevocable trust cannot be modified or revoked by the grantor. Once the trust has been created, it cannot be changed or undone by the person who made it.
So, what is a trust?
- A trust is a legal entity that holds assets managed by a trustee to benefit one or more beneficiaries.
- The terms of the trust state how the assets are to be managed and distributed to the beneficiaries. Just like a person can own property or assets, a trust can also own property or assets.
Irrevocable trusts even have a tax identification number with the IRS for income tax purposes!
Some people choose to set up revocable trusts, which may be amended or even canceled by the grantor at any time, contrary to irrevocable trusts.
Even though assets are placed into the trust, the grantor effectively retains ownership rights to the property. To regain ownership of the assets, he or she simply needs to cancel the trust.
Irrevocable trusts can either be established as a living trust or testamentary trust.
- Living trusts, also called inter vivos trusts, are established during the grantor’s lifetime. This means that a person creates the trust during their lifetime and places property or assets into it. The person relinquishes all ownership rights to the property at that time.
- On the other hand, testamentary trusts are established after a person’s death through provisions in their will. Testamentary trusts are always irrevocable because it would be impossible for the person to change or revoke the trust after death.
A living trust may be established as either a revocable living trust or an irrevocable living trust.
KEY TAKEAWAYS
- One of the main reasons for establishing an irrevocable trust is the tax benefits.
- Irrevocable trusts will have their own tax ID number and be responsible for any tax filings/liabilities.
- A irrevocable trust cannot be changed or revoked once it is in place, except in a few special circumstances.
How Irrevocable Trusts Work For Estate Planning
One of the main reasons for using an irrevocable trust for estate planning is the tax benefits.
- If properly established, an irrevocable trust allows the grantor to relinquish all ownership rights in any property or assets placed in the trust.
Those assets are no longer considered part of the grantor’s estate. Reducing the value of one’s estate also reduces the amount of federal estate tax that will be due when it comes time to probate the will.
- Another reason that one might choose to establish an irrevocable trust is for asset protection.
This is particularly useful for those in professions who are at a high risk for litigation like doctors or lawyers. Once placed into the trust, the assets are shielded from creditors of the individual.
In effect, any trust assets are unaffected by lawsuits or judgments against the grantor. Some states allow an exception for assets placed in the trust after a lawsuit has been filed or soon before a lawsuit is filed.
- Irrevocable trusts also allow for the avoidance of probate during the distribution of the estate, and they provide privacy for the details of the distribution.
Probate court proceedings become public record, but the details of a trust remain private.
- One might use a trust to deplete one’s assets to qualify for government benefits like Medicaid or other Social Security benefits.
Trust assets do not count as the grantor’s assets, so by divesting assets into a trust, the grantor can qualify for benefits they might otherwise have to pay for with personal funds.
Must read articles related to Trusts
- Overview of “What is a trust?“.
- Deep dive into understanding revocable trusts.
- What are the differences between a revocable and irrevocable trust?
- How does a charitable remainder trust work?
- Learn about the benefits of living trusts.
Common Types Of Irrevocable Trusts
There are many different types of irrevocable trusts that might be included as part of an overall estate plan. Here we will discuss some of the more common types of these trusts.
Living Irrevocable Trust
This trust is created during the grantor’s lifetime but cannot be changed or revoked once established. The only exception to this rule is when all the beneficiaries agree to the change, which the court will generally allow. Once this type of trust is funded, the grantor gives up all ownership rights to the trust assets.
Testamentary Trust
A testamentary trust is established during the probate process through the provisions of a will. By its very nature, a testamentary trust is irrevocable because the grantor is already deceased. It is funded with assets from the estate according to the terms of the will.
Irrevocable Life Insurance Trust (ILIT)
An ILIT is established to receive the proceeds from a life insurance policy. This prevents those proceeds from being included in the deceased’s estate. Establishing this type of trust can save lots of money in estate taxes, mainly if the insurance policy is large.
Special Needs Trust
A special needs trust allows a physically or mentally disabled person to receive proceeds from the trust while still being able to qualify for Social Security benefits like Supplemental Security Income (SSI), SSDI, or Medicare.
Charitable Trust
A charitable trust may be established as a charitable remainder trust or a charitable lead trust. The remainder trust allows the trustee to distribute assets to the beneficiaries first and the remainder to a charity, while the lead trust allows the charity to receive assets first, with the rest going to the beneficiaries.
TIP
Suppose estate assets prevent you from qualifying for Medicaid. In that case, you may be able to transfer assets into an Irrevocable Trust to lower the value of your assets and potentially be eligible for Medicaid.
Irrevocable Trust Taxes And Setup Costs
Once assets are placed in an irrevocable trust, the settlor (grantor) no longer has ownership rights to them.
- The trust’s assets may continue to earn income, such as interest, rent from real estate, capital gains, or other types of income.
- The trust must pay taxes on that income. It will have its own tax ID number and must file a tax return with the IRS each year. The taxes must be paid from the trust fund account.
One of the main differences between irrevocable trusts and revocable trusts is that you do not see the same tax benefits with a revocable trust.
The cost of setting up a trust varies based on its complexity and the value of the assets. An experienced estate planning attorney drafting a basic trust document can expect to charge at least a few hundred dollars.
If your personal finances require complex trust documents, you will likely be paying $5,000 or more for appropriate legal advice and to have the documents drafted.
Once established, the trust will also incur management fees going forward. These can range from a few hundred dollars per year to several thousand, depending on the size of the trust.
Methods For Changing An Irrevocable Trust
By its very nature, an irrevocable trust cannot be changed or revoked once it is in place.
However, there are a couple of exceptions to this rule.
- The first and easiest way to change an irrevocable trust is with the beneficiaries’ consent. If all the beneficiaries agree to the change, the court will generally allow a shift in the trust agreement.
- The other method for making changes is by including a provision in the trust which allows the trustee to make changes based on extenuating circumstances. For example, a parent might establish a trust to be used for education expenses for a child. Suppose that a child develops a severe medical condition that requires expensive treatment. The trust may allow the trustee the flexibility to use funds for medical treatment instead of education expenses.
Some ask, “Can you remove a beneficiary from a trust?” If the trust is irrevocable, then the answer is likely no.
With a revocable trust, you can change it at any time. However, a beneficiary of an irrevocable trust will not likely agree to be removed from the trust; therefore, you would not be able to amend the trust document.
Irrevocable Trusts And Medicaid Qualification
Most people with large estates will not qualify for Medicaid. If they need to go to a nursing home, they must pay for those expenses out of pocket.
This could quickly deplete all the assets in their estate and leave their children with no inheritance. By placing your assets into an irrevocable trust, they are no longer included as part of your assets. This effectively lowers the value of your assets and might qualify you for Medicaid.
If you plan to go this route, make sure you start early. Assets must stay in the trust for several years before being shielded from Medicaid recovery after the grantor’s death.
If the grantor places assets into the trust and then starts receiving Medicaid benefits the following month, then Medicaid may be able to recover the payments they made.
The Bottom Line
Irrevocable trusts are powerful estate planning tools used chiefly for estate tax purposes.
Though the estate tax exemption is currently quite high, irrevocable trusts can still be used to avoid estate and gift taxes when transferring assets to family and friends.
Placing assets in the trust effectively lowers the value of one’s taxable estate, and it also avoids the lengthy and complicated probate process.
If you think you might benefit from creating an irrevocable trust, then you should discuss it with your estate planning attorney.
Frequently Asked Questions
An irrevocable trust cannot be changed or amended, while a revocable trust can be changed at any time by the grantor.
Once assets are placed into an irrevocable trust, the grantor loses all ownership rights.
With a revocable trust, the grantor essentially retains ownership of the property in the trust because he or she can choose to revoke it at any time.
An irrevocable trust is a good idea because it provides many benefits that are unavailable with a simple will.
Trusts can save you money on estate taxes, keep the details of your estate private, and avoid the lengthy probate process. It can be used to transfer assets during your life or after your death.
Make sure you consult a qualified attorney when comparing a living trust vs a will.
The most obvious downside to an irrevocable trust is the fact that it cannot be amended once it has been created.
Along those same lines, the grantor must relinquish all ownership rights to the assets placed in the trust. At that point, the assets belong wholly to the trust, and the trustee makes all decisions related to the management of the assets.
Irrevocable trusts also come at a cost. Attorney fees for creating the trust documents, plus ongoing management costs, can get quite expensive.
This is not an apples-to-apples comparison. Living trusts are created during the grantor’s lifetime. They can be either revocable or irrevocable.
An irrevocable trust may be a living trust or a testamentary trust. If it is created during the grantor’s lifetime, it is a living trust.
If it is created after the grantor’s death through provisions in the will, it is considered a testamentary trust.
You can find a Social Security Administration office near you by using our SSA office locator and searching for your closest location.
