Irrevocable Trust - Explained
What is an Irrevocable Trust?
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Table of ContentsIrrevocable Trust DefinitionA Little More on What is an Irrevocable TrustImportant PointsDifferent Types of Irrevocable TrustsBasics of Irrevocable TrustsDifferences and Similarities Between Irrevocable Trusts and Revocable TrustsAcademic Research
Back to: INHERITANCE, ESTATES, & TRUSTS
What is an Irrevocable Trust?
In an irrevocable trust, the terms and conditions of the trust cannot be changed, amended, or terminated without the order or permission of the grantors beneficiary or named beneficiaries. In such a trust, the grantor legally transfers all rights to the beneficiaries, so they themselves have no other right in the trust. Thus, any changes to the agreements can only be carried out by the named beneficiary or beneficiaries (in case of multiples). An irrevocable trust is the opposite of a revocable trust. In a revocable trust, the grantor has a right to modify the terms of the trust, but in doing so, he or she loses certain benefits such as creditor protection. In estate planning trusts are very essential as they help to settle disputes and make things go smoothly in the future. Thus, it is a myopic statement to say that trusts are meant for just the wealthy.
How Does an Irrevocable Trust Work?
In most cases, irrational trusts are set up for the purpose of estate and tax considerations. This type of trust comes with the benefit that it removes all incidents of ownership, and thus, it removes the estate from the grantors taxable estate. Thus, any tax on such an estate wouldn't affect the grantor in any form. Irrevocable trusts also relieve the grantor from any tax liability or debt on any income amount which the asset generates. In most cases, the grantor will be unable to receive such benefits if they are the trustee of the trust. However, this varies with each jurisdiction, as some act otherwise. The asset held in the trust can consist of investment assets, life insurance policies, and cash. They are also a number of assets that can be held in trusts for beneficiaries. The process of setting up a trust can be very complex, and thus, an attorney is needed for this action. As such trusts are thought as an investment or practice for the very wealthy individuals in the country, and this believe is sometimes true given the high setup fee charged by attorneys for irrevocable trusts. Although this believe is widespread, it is also essential to note the importance of trusts for modest individuals in estate and legacy planning. For example, whenever a trust creator doesn't trust a beneficiary to receive a huge sum of money without restrictions, plans for disbursal, or consideration of its use. Irrevocable trusts are usually useful to a large extent for individuals who work in professional fields that make them vulnerable to lawsuits. Two perfect examples of such fields are doctors and attorneys. Once a property is transferred to such a trust, it is owned by the trust on behalf of the named beneficiary or beneficiaries. This way, any issues faced by the grantor wont affect the trust, as ownership has been legally passed out from the grantor to the trust for the beneficiary. Thus, any lawsuit against the grantors estate or assets wont affect the property as the ownership of the trust asset has been transferred out from him. In this modern era, irrevocable trusts come with different benefits which were not present in the older days when the instrument was first implemented. The additions made to this system of trust allowed for higher flexibility and modifications in trust management and the distribution of assets. A perfect addition to the working system of irrevocable trusts is the decanting system which allows for a trust to be relocated or moved into a more modern trust or one with more beneficial provisions. Decanting allows for better and easier management of a trust in the present and in the future. Other additions can help a trust to have tax benefits and extra savings like those that allow for change of state of domicile.
- An irrevocable trust is any type of trust where the grantor has no power to make amendments or modifications to the terms of the trust. Also, in this type of trust, the grantor also has no power to terminate the trust without the permission of the beneficiary or named beneficiaries.
- In such a trust, the grantor legally removes all ownership of the asset or the property being trusted to the beneficiary. Thus any lawsuit against the grantor wont affect the property in the trust.
- Irrevocable trusts cannot be modified or altered after creation, and even if they could, the process is so complex and complicated that it'd be better to leave it as is.
Irrevocable trusts are sometimes better than revocable trusts in the sense that they offer substantial tax benefits which revocable trusts do not offer.
Different Types of Irrevocable Trusts
There are primarily two forms of irrevocable trusts: Living trusts and testamentary trusts. In a living trust, the contract of the trust and the setup in generally is enacted and funded by the grantor during their lifetime. A living trust is also called an inter-vivo trust (inter-vivo is Latin for between the living), and some notable examples of such trusts are:
- Irrevocable life insurance trust
- Grantor-retained annuity trust (GRAT), spousal lifetime access trust (SLAT) and qualified personal residence trust (QPRT) (all types of lifetime gifting trusts)
- Charitable remainder trust and charitable lead trust (both forms of charitable trusts).
Testamentary trusts on the other hand are trusts that are designed to be effectively irrevocable as theyre created after the death of their creator. These trusts are financed from the deceased grantors estate according to the conditions stated in their will. The only way through with an individual can cancel or make changes to a testamentary trust is by altering or modifying the will of the creator of the trust before they die.
Basics of Irrevocable Trusts
In an irrevocable trust, these three parties are always present for the setup to be enacted: a grantor, a trustee, and a beneficiary or a list of named beneficiaries. Immediately the grantor places an item or an asset in the trust, it is non-retractable as such an asset would be described as a gift to the grantor. The grantor in this case can only dictate or decide the use of the assets being put into the trust, but for this to be possible, the grantor would also require the consent of both the beneficiary and the trustee. Irrevocable trusts have many applications in estate and legacy planning in relations to distribution of assets and the preservation of property. The various applications include, but are not limited to the following:
- To take advantage of the estate tax exemption and remove taxable assets from the estate. Property transferred to an irrevocable inter-vivo trust is not counted towards the gross value of an estate. Such trusts can be especially helpful in tax reduction and mitigation of tax liabilities or debts of enormously huge estates.
- To prevent beneficiaries or a named beneficiary from misusing assets, as the grantor can set different terms and conditions for the distribution of such an asset.
- To donate assets and financial instruments while still keeping the income gains from such an asset.
- To eliminate appreciable assets from the estate while offering beneficiaries with an upgrade basis in valuing assets for tax purposes.
- To gift a principal residence to children under more favorable tax rules.
- To hoard or protect a life insurance policy that would remove the death benefits from the grantors estate.
- To deplete ones property to ensure eligibility for government benefits like Social Security income and Medicaid. These types of trusts can also be used to secure benefits and care for a special needs child by avoiding disqualification of eligibility.
Irrevocable trusts are more complex compared to revocable when it comes to setting them up. It is advisable to seek a tax attorney or an estate attorney when establishing an irrevocable trust as there could be current income tax and future estate tax implications when using such a trust.
Differences and Similarities Between Irrevocable Trusts and Revocable Trusts
Revocable trusts are modifiable and alterable at any time as long as the grantor of such a trust is mentally capable. The creator or grantor also has the full right to cancel such a trust whenever they wish. Also, in a revocable trust, the creator or the grantor is eligible to receive benefits when he or she cancels the trust before their death, and they will be allowed to reclaim their property. However, a revocable trust doesn't offer the same legal action or tax treatment as an irrevocable trust. In a case where a trust is revocable, the grantor is still given the status of the ownership of the trust, and in a case of lawsuit, the assets under the trust will still be held as property of the grantor. A revocable trust is automatically given the status of an irrevocable trust after the grantor or creator the trust dies.
- Declaration of Trust
- Uniform Gifts for Minors Act
- Acceptance of Office by Trustee
- Beneficial Interest
- Asset Protection Trust
- Bare Trust
- Blind Trust
- Charitable Lead Trust
- Charitable Remainder Trust
- Charitable Remainder Annuity Trust
- Charitable Gift Annuity
- Credit Shelter Trust
- Discretionary Trust
- Generation Skipping Trust
- Grantor Trust Rules
- Living Trust
- Inter Vivos Trust
- Revocable Trust
- Irrevocable Trust
- Irrevocable Income-Only Trust
- Qualified Domestic Trust (QDOT)
- Qualified Terminal Interest Protection Trust (QTIP)