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Irrevocable Trust: Setup Costs, Trust Types & More | Complete Guide

Accountant Verifying Financial Statements

Most people tend to think that trust funds are only for the super wealthy. That is not always the case as trusts can provide many benefits even to an individual of average financial status. Before diving forward and establishing a trust, you should learn the basics of trusts and when to use them. There are different categories of trusts and each has pros and cons. In this article, we will examine irrevocable trusts in more detail. Even within irrevocable trusts, there are many types and each has a fairly specific use. Keep reading to learn more about the different types, setup costs, benefits, and more.


What Is An Irrevocable Trust?

An irrevocable trust, as the name implies, is a trust that cannot be modified or revoked by the grantor. This means that once the trust has been created, it cannot be changed or undone by the person who created it. So, what is a trust fund? A trust is a legal entity that holds assets managed by a trustee for the benefit of 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 be the owner of property or assets. Irrevocable trusts even have their own tax identification number with the IRS for income tax purposes!

Contrary to irrevocable trusts, some people choose to set up revocable trusts. These trusts may be amended or even cancelled completely by the grantor at any time. Even though assets are placed into the trust, the grantor effectively retains ownership rights to the property. He or she simply needs to cancel the trust to regain ownership of the assets.

Irrevocable trusts can either be established as a living trust or testamentary trust. Living trusts are established during the grantor’s lifetime. These are also called inter vivos trusts. This means that a person creates the trust during their lifetime and places property or assets into the trust. The person relinquishes all ownership rights to the property at that time. Testamentary trusts, on the other hand, 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 they are deceased. A living trust may be established as either a revocable living trust or irrevocable living trust.


How Irrevocable Trusts Work For Estate Planning

One of the main reasons for using an irrevocable trust for estate planning is for the tax benefits. If properly established, an irrevocable trust allows the grantor to completely give up all ownership rights in any property or assets placed into the trust. This means that 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 assets of the trust are not affected by lawsuits or judgments against the grantor. Some states do 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 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. Finally, one might use a trust to deplete one’s own assets in order to qualify for government benefits like Medicaid or some Social Security benefits. Trust assets do not count as assets of the grantor, so by divesting a large number of assets into a trust, the grantor can qualify for benefits they might otherwise have to pay for with personal funds.


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 kind of trust is created during the grantor’s lifetime, but it cannot be changed or revoked once established. The only exception to this rule is when all the beneficiaries agree to the change, the court will generally allow it. 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 as part of the deceased’s estate. Establishing this type of trust can save lots of money in estate taxes, particularly if the insurance policy is a large one.


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.


Irrevocable Trust Taxes And Setup Costs

Older Man Calculating Irrevocable Trust Taxes And Setup Costs

Once assets are placed into an irrevocable trust, the settlor (grantor) no longer holds any ownership rights to the assets. The trust’s assets may continue to earn income like interest, rent from real estate, capital gains, or other types of income. The trust itself must pay taxes on that income. The trust will have its own tax ID number, and it 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 the complexity of the trust and the value of the assets. You can expect to pay at least a few hundred dollars for an experienced estate planning attorney to draft a basic trust document for you. If your personal finances require complex trust documents, then 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 costs for management fees going forward. These can range from a few hundred dollars per year to several thousand based 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 consent of the beneficiaries. If all the beneficiaries agree to the change, then the court will generally allow a change to 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 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 people 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 is not likely to agree to being 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. Should they need to go into a nursing home, they would be required to pay out of pocket for those expenses. 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 need to stay in the trust for a number of years before they are 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 that are used mostly 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 into the trust effectively lowers the value of one’s taxable estate, and it also avoids the lengthy and complicated probate process. If you think that you might be able to benefit from the creation of an irrevocable trust, then you should have a discussion with your estate planning attorney today.


Frequently Asked Questions

What is the downside of an irrevocable trust?

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 totally relinquish all ownership rights to the assets that are 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 the creation of the trust documents plus on-going management costs can get quite expensive.


What is the difference between a living trust and an irrevocable trust?

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 an irrevocable trust is created during the grantor’s lifetime, then it is a living trust. If created after the grantor’s death through provisions in the will, then it is considered a testamentary trust.


Why is an irrevocable trust a good idea?

An irrevocable trust is a good idea because it provides many benefits that are not available 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 that you consult a qualified attorney when comparing a living trust vs a will.


What’s the difference between an irrevocable trust and a revocable trust?

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 to those assets. However, with a revocable trust, the grantor essentially retains ownership of the property in the trust because he or she could choose to revoke it at any time.