What Is an Irrevocable Trust?

What Is an Irrevocable Trust?

Let me explain what an irrevocable trust is. It's designed to shift assets out of your control as the grantor and into the beneficiary's name. This move protects those assets from creditors and shrinks the value of your estate, which cuts down on estate taxes.

You can't modify, amend, or end an irrevocable trust without the beneficiary's okay or a court order. Rules can differ by state, so keep that in mind.

Key Takeaways

Irrevocable trusts pull assets out of your taxable estate by handing ownership to the trust, potentially lowering estate taxes and guarding against creditors. Once you set it up, the terms are fixed—you need beneficiaries' consent or a court order to change or cancel it.

As the grantor, you give up control; legal ownership goes to the trustee, and you can't touch or manage the assets directly. These trusts are often used for estate planning, qualifying for Medicaid, and protecting assets from lawsuits or claims.

They come in different types, like living (inter vivos) and testamentary irrevocable trusts, each tailored for things like tax strategies (think ILITs or GRATs) or helping special needs beneficiaries.

How an Irrevocable Trust Works

Irrevocable trusts are typically created to cut estate taxes, tap into government benefits, and shield assets. Unlike a revocable trust, where you can tweak or scrap it but get no creditor protection, an irrevocable one locks things in.

You transfer ownership of assets to the trust, stripping away all your rights to them. This takes the assets out of your taxable estate and shifts any income tax burden off you. But remember, tax rules vary by location, and you can't reap these perks if you're the trustee—the one duty-bound to manage assets for the beneficiary.

These trusts help people in high-risk jobs, like doctors or lawyers, who might face lawsuits. Once an asset is in the trust, it's owned by the trust for the beneficiaries' benefit, so it's out of reach from judgments or creditors—the trust isn't involved in any legal mess.

Modern irrevocable trusts have features that older ones lacked, adding flexibility. Things like decanting let you move the trust into a new one with better terms, ensuring effective management. You can even change the trust's home state for tax advantages or other gains.

Types of Irrevocable Trusts

Irrevocable trusts fall into two main categories: living trusts and testamentary trusts.

A living trust, or inter vivos trust, is set up and funded while you're alive. Examples include irrevocable life insurance trusts (ILITs), grantor-retained annuity trusts (GRATs), spousal lifetime access trusts (SLATs), qualified personal residence trusts (QPRTs), and charitable trusts like remainder or lead trusts.

Testamentary trusts are irrevocable by nature since they're created after the grantor's death, funded from their estate based on the will. The only way to adjust or cancel one is by changing the will before death.

Irrevocable Trust Uses

Irrevocable trusts play key roles in estate preservation and distribution. They let you use the estate tax exemption to remove taxable assets from your estate—property in an irrevocable living trust doesn't count toward your estate's value, which is great for big estates.

You can prevent beneficiaries from squandering assets by setting distribution conditions. They allow gifting assets while keeping the income, or removing growing assets from the estate while giving beneficiaries a step-up in basis for taxes.

These trusts can gift a home to kids under better tax rules, hold life insurance to exclude proceeds from the estate, or reduce your property to qualify for benefits like Social Security or Medicaid. They're also useful for special needs kids, avoiding benefit disqualification.

Irrevocable Trusts vs. Revocable Trusts

Revocable trusts can be changed or canceled anytime if you're mentally competent, letting you reclaim property before death. But they don't protect against lawsuits or estate taxes like irrevocable ones do.

With revocable trusts, assets are still seen as yours for tax or benefit purposes. After death, they become irrevocable.

SECURE Act Rules

The SECURE Act alters tax benefits for see-through trusts. Before, some non-spousal beneficiaries could spread distributions over their lifetime. Now, they might have to take everything by the end of the 10th year after the grantor's death.

How Does an Irrevocable Trust Work?

An irrevocable trust can't be altered or ended without court or beneficiary approval. It removes assets from your taxable estate, transferring ownership to the trust. This setup cuts tax liabilities and adds protections from creditors and lawsuits.

What Is the Difference Between an Irrevocable and a Revocable Trust?

Irrevocable trusts are fixed and can't be changed or ended, offering creditor and lawsuit protection, while revocable ones can be adjusted but lack those safeguards.

Who Controls an Irrevocable Trust?

The trustee holds legal ownership in an irrevocable trust, while you as grantor surrender rights. You can't control or change assets once transferred, unless the beneficiary agrees.

The Bottom Line

Irrevocable trusts cut estate taxes and protect assets. Living ones are made during life, testamentary after death via will. They're complex with tax implications, so consult a tax or estate attorney before setting one up.