An irrevocable trust is one of the most indispensable estate planning tools. It can be used to access certain government benefits, minimize estate taxes, and protect assets within the trust. Irrevocable trusts differ from revocable trusts, which let the grantor modify the trust, but at the cost of certain advantages.
One of the main purposes of an irrevocable trust is to provide beneficiaries of an estate with certain protections. However, this sort of protection comes with a few downsides, the foremost being its high cost. Some trusts can be complex enough to warrant the services of an attorney, whose fees can raise the cost of setting up a trust significantly.
In this article, we talk about how irrevocable trusts can be useful, why someone would want an irrevocable trust, its differences with revocable trusts, and other useful information.
An irrevocable trust is necessary when an individual has a large estate that would otherwise be subject to hefty taxes without it. In general, setting up an irrevocable trust for the assets in a sizable estate would exempt them from taxes and decrease the grantor’s tax liability.
When you help clients set up an irrevocable trust, the trust can also avoid probate. This means that the assets held within the trust are kept private, as are the terms of their dispensation.
Making a trust part of their estate planning is also beneficial for clients who are engaged in high-risk professions that can incur lawsuits, such as doctors or lawyers. By placing the assets they’d like to bequeath in an irrevocable trust, the assets are placed out of the reach of creditors.
This is the legal process of reviewing the assets of a deceased person and determining who inherits them. The probate process usually focuses on determining the existence, authenticity, and validity of a will. This process can be initiated with or without an existing will.
Note that in estate planning, a last will and testament usually calls for probate (especially when large estates are involved), while most trusts avoid the probate process.
Irrevocable trusts come in two main categories:
Under living trusts, there are some common examples:
This is a tool used in estate planning that initially indirectly benefits heirs. By placing assets in a GRAT while the grantor is still living, taxes on large financial gifts to family members are kept to a minimum. Under a GRAT, an irrevocable trust is set up for a specific period.
As assets are placed in the trust, an annuity is paid to the grantor each year. Once the trust expires and the grantor receives the last annuity payment, the beneficiary can then receive the assets as a gift. The beneficiary pays a small gift tax, or no gift tax in this setup.
In this trust setup, the grantor is insured by a term or life insurance policy while they are alive. The parties involved in an ILIT are the grantor, the trustees, and the life insurance policy’s beneficiaries. Be sure to know more about the nuances of irrevocable trusts and their terms in more detail.
An ILIT allows the grantor to own and control their term or life insurance policy while they are alive, and then manage and give out the proceeds upon their death.
This is an estate planning tool wherein the grantor can pursue philanthropic goals even as they earn income. Charitable remainder trusts involve having the grantor donate to a charitable organization, then get tax deductions.
Income is dispensed to either the grantor or noncharitable beneficiaries for a specific period, then what remains of the trust is donated to one or more beneficiaries. The final beneficiaries may be a private foundation or public charity.
Some may argue that testamentary trusts are technically revocable trusts, presuming that their terms may be changed via the grantor who makes changes in their will. This cannot hold true, since the testamentary trust is merely a provision or condition of an existing will, assigning the executor of the will and instructing the executor to create the trust.
In effect, it is the will that was changed or “revoked” but the testamentary trust remains unchanged. The trust is not immediately created after the person’s death but is created only after the will completes the probate process, and no changes can be made without the consent of all the beneficiaries or a court approval.
Irrevocable trusts offer key features that make them favorable tools used for estate planning. Here are their main features:
For lower income Americans, there are beneficial government programs like Medicaid that provide for long-term medical care. If an individual has assets that may not be enough to fund their long-term care but prevent them from getting Medicaid, they can use an irrevocable trust to qualify.
To be eligible, Medicaid requires individuals to prove that their assets and income are limited. Setting up an asset protection trust can help individuals stay within the Medicaid asset threshold.
Medicaid has a “look-back” period of 5 years to determine if an individual disposed of assets within that period to qualify for Medicaid. Investors should consult an estate planning attorney to see if an asset protection trust can help get them Medicaid or other government programs.
Irrevocable trusts are useful for those engaged in professions that are prone to lawsuits such as:
An asset protection trust would greatly benefit clients like these and give them more peace of mind. Learn and try out some of the asset protection trusts strategies to help protect your assets.
Estate taxes can be potentially burdensome, depending on the size of your clients’ estate. The federal estate tax can range from 18% to an eye-popping 40%. For most ordinary Americans, this may not be of concern. But if your clients have assets worth over $12.92 million in 2023 (or $13.61 million in 2024), then they will have to pay hefty estate taxes.
Placing these assets in an irrevocable trust can help your clients avoid the large tax bill. Some U.S. states have their own tax rates and levy taxes even on smaller estates.
Federal tax exemptions may also change in the coming years, so it’s best to help clients plan.
Since the irrevocable trust is the owner of the assets, they cannot be subjected to the probate process. In a probate process, your client’s assets can become a matter of public record. Avoiding probate helps keep your client’s assets private.
Speaking of assets, it’s crucial to note that trusts won’t function unless they are funded or have assets in them. Here’s a video detailing how to put assets into a trust. You’ll also learn what sorts of assets can be placed in a trust:
Knowing which is better suited to your clients’ needs means weighing up the factors that can influence this decision.
Due to its flexibility, the revocable living trust can be a viable option. It also allows the grantor to remain fully in control of their assets even when placed in the trust. But when it comes to carrying out specific wishes for assets, the irrevocable trust is the better option.
Factors or situations that can influence choosing revocable over irrevocable trusts can include:
If the estate in question is valuable enough to cost its beneficiaries hefty estate taxes and income taxes, then an irrevocable trust would be best to limit or avoid these taxes.
Conversely, if the estate is not large enough to incur heavy taxes, then a last will and testament without an additional trust may suffice.
There may be cases when a grantor passes away when their named beneficiaries are still minors. In this case, an irrevocable trust can manage the assets and ensure that the grantor’s heirs do not waste their inheritance.
With an irrevocable trust, a trustee can be appointed to manage the assets and make payouts from the estate based on the grantor’s wishes. For example, the trustee can ensure that the beneficiaries receive a specific sum when they:
A revocable living trust could apply in this case. If the grantor executes a GRAT, then they can give part of the inheritance as financial “gifts” to their beneficiaries. The recipients, in turn, pay a small gift tax, or no taxes at all.
There may be cases where an individual is unable to make financial decisions due to serious injury or illness. In these instances, a revocable living trust is more appropriate.
The revocable living trust appoints a trustee who oversees the trust assets and handles their distribution to beneficiaries, but only when the grantor passes away. Doing this also avoids the probate process.
A probate's cost can sometimes be measured in terms of money and time. If your client’s estate is small and simple, then a probate can take as little as six to eight months to complete and give the heirs their fair share.
Your client might be better off setting up an irrevocable trust if they foresee issues like:
Irrevocable trusts can be an excellent estate planning tool. This can be essential in managing a client’s assets and acting in their best interests.
Using these tools can sometimes be more about when, and not if, you should use them. Depending on the client’s wishes, size of their estate, and budget, it’s not uncommon to use both revocable and irrevocable trusts.
For the best outcome for your clients, consider the best approach that makes optimal use of your client’s time, wishes for their beneficiaries, and their resources.
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