What Is an Irrevocable Trust?
The purpose of an irrevocable trust is to move the assets from the grantor's control and name to that of the beneficiary. This reduces the value of the grantor's estate in regard to estate taxes and protects the assets from creditors.
Irrevocable trusts cannot be modified, amended, or terminated without the permission of the grantor's beneficiary or by the order of a court.The exact rules can vary by state. The grantor, having effectively transferred all ownership of assets into the trust, legally removes all of theirrights of ownership to the assets and the trust.
Irrevocable trusts are generally set up to minimize estate taxes, access government benefits, and protect assets. This is in contrast to a revocable trust, which allows the grantor to modify the trust, but loses certain benefits such as creditor protection.
Key Takeaways
- Irrevocable trusts cannot be modified, amended, or terminated without permission from the grantor's beneficiaries or by court order.
- The grantor transfersall ownership of assets into the trust and legally removes all of their ownership rights to the assets and the trust.
- Living and testamentary trusts are two types of irrevocable trusts.
- These trusts offer tax-shelter benefits that revocable trusts do not.
- Under the SECURE Act, some beneficiaries may have to take a full distribution by the end of the tenth calendar year following the year of the grantor's death.
How an Irrevocable Trust Works
Irrevocable trusts are primarily set up for estate and tax considerations. That's because it removes all incidents of ownership, removing the trust's assets from the grantor's taxable estate. It also relieves the grantor of the tax liability on the income generated by the assets. While the tax rules vary between jurisdictions, the grantor can't receive these benefits if they arethe trustee. The assets held in the trust can include (but are not limited to) a business, investment assets, cash, and life insurance policies.
Trusts have an important place in estate and legacy planning. But there is a downside: the cost. Setting up any type of trust can be complicated enough that an attorney is necessary. And this means that people may end up spending a few thousand dollars or more in attorney fees to set them up.
Irrevocable trusts are especially useful to individuals who work in professions that may make them vulnerable to lawsuits, such as doctors or attorneys. Once an asset is transferred to such a trust, it is owned by the trust for the benefit of its beneficiaries. Therefore,it is safe from legal judgments and creditors since the trust will not be a party to any lawsuit.
Today’s irrevocable trusts come with many provisions that were not commonly found in older versions of these instruments. These additions allow for much greater flexibility in trust management and distribution of assets. Provisions such as decanting, which allows a trust to be moved into a newer trust with more modern or advantageous provisions, can ensure that the trust assets will be managed effectively. Other features that allow the trust to change its state of domicile can provide additional tax savings or other benefits.
Although they are commonly associated with the very wealthy, trusts are an important piece of estate planning for anyone—regardless of income status.
Types of Irrevocable Trusts
Irrevocable trusts come in two forms: living trusts and testamentary trusts.
A living trust, which is also known as an inter vivos (Latin for "between the living") trust,is originated and funded by an individual during their lifetime. Some living trust examples 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 irrevocable by design. That's because they are created after the death of their creator and arefunded from the deceased'sestate according to the terms of their will. The sole way to make changes to a testamentary trust (or cancel it) is to alter the will of the trust's creator before they die.
Irrevocable Trust Uses
An irrevocable trust has a grantor, a trustee, and a beneficiary or beneficiaries. Once the grantor places an asset inan irrevocable trust, it isa gift to the trust and the grantor cannot revoke it. The grantor can dictate the terms, rules, and uses of the trust assets with the consent of the trustee and the beneficiary.
Irrevocable trusts can have many applications in planning for the preservation and distribution of an estate, including:
- To take advantage of the estate tax exemption and remove taxable assets from the estate. Property transferred to an irrevocable living trustdoes not count toward the gross value of an estate. Such trusts can be especially helpful in reducing the tax liability of very large estates.
- To prevent beneficiaries from misusing assets, the grantor can set conditions for distribution.
- Togift assets to the estate while still retaining the income from the assets.
- To remove appreciable assets from the estate while still providing beneficiaries with a step-up basis in valuing the assets for tax purposes.
- To gift a principal residence to children under more favorable tax rules.
- To house a life insurance policy that would effectively remove the death proceeds from the estate.
- To depleteone's property to ensure eligibility for government benefits, such as Social Security income and Medicaid (for nursing home care). Such trusts can also be used to help secure benefits and care for a special needs child by preventingdisqualification ofeligibility.
An irrevocable trust is a more complex legal arrangement than a revocable trust. Because there could be current income tax and future estate tax implications when using an irrevocable trust, seek a tax or estate attorney's guidance.
Irrevocable Trusts vs. Revocable Trusts
Revocable trusts may be amended or canceled at any time as long as their creator is mentally competent. They do offer the benefit of allowing their creator to cancel them and reclaim property held by the trust at any time before death.However, such trusts do not offer the same protection against legal action or estate taxes as irrevocable trusts.
When using revocable trusts, government entities will consider that any property held in one still belongs to the trust's creator and therefore may be included in their estate for tax purposes or when qualifying for governmentbenefits. Once a revocable trust's creator dies, the trust becomes irrevocable.
SECURE Act Rules
The Setting Every Community Up for Retirement Enhancement (SECURE) Act changes some of the tax-saving benefits of see-through trusts.
Previously, certain non-spousal beneficiaries of retirement accounts that had been placed in an irrevocable trust could take their distributions over their life expectancy. However, under the SECURE Act rules, some beneficiaries may find they must take a full distribution by the end of the tenth calendar year following the year of the grantor's death.
Again, because the tax implications of this can be challenging and can change with the passage of new laws, it's important to consult a tax or estate attorney's guidance when using an irrevocable trust.
How Does an Irrevocable Trust Work?
An irrevocable trust cannot be changed or modified without the beneficiary's permission. Essentially, an irrevocable trust removes certain assets from a grantor’s taxable estate, and these incidents of ownership are transferred to a trust. A grantor may choose this structure to relieve assets in the trust from tax liabilities, along with other financial benefits.
What Is the Difference Between an Irrevocable and a Revocable Trust?
First, irrevocable trusts cannot be changed or altered. Among the primary reasons they are used is for tax reasons, where the assets in the trust are not taxed on income generated in the trust, along with taxes in the event of the benefactor's death. Revocable trusts, on the other hand, can change. Beneficiaries may be removed and stipulations may be modified, along with other terms and management of the trust. However, when the owner of the trust dies, the assets held in the trust realize state and federal estate taxes.
Who Controls an Irrevocable Trust?
Under an irrevocable trust, legal ownership of the trust is held by a trustee. At the same time, the grantor gives up certain rights to the trust. Once an irrevocable trust is established, the grantor cannot control or change the assets once they have been transferred into the trust without the beneficiary's permission. These assets can include a business, property, financial assets, or a life insurance policy.
FAQs
Irrevocable trusts come in two forms: living trusts and testamentary trusts.
What is an irrevocable trust and how does it work? ›
Irrevocable trust refers to any trust where the grantor cannot change or end the trust after its creation. Grantors may choose a trust with such limitations to limit estate taxes or to shield assets from creditors.
What is a simple explanation of irrevocable trust? ›
In an irrevocable trust, the grantor transfers property to the trust and once those assets are transferred, they are beyond the grantor's reach. However, grantors at times retain an interest in some or all of the trust assets.
What are the only 3 reasons you should have an irrevocable trust? ›
Irrevocable trusts have some notable advantages.
- Potential estate tax savings. The federal estate tax ranges from rates of 18% to 40% and generally only applies to assets over $12.06 million in 2022 or $12.92 million in 2023. ...
- Protection from creditors. ...
- Qualification for certain government programs.
The downside of irrevocable trust is that you can't change it. And you can't act as your own trustee either. Once the trust is set up and the assets are transferred, you no longer have control over them, which can be a huge danger if you aren't confident about the reason you're setting up the trust to begin with.
Can you withdraw money from an irrevocable trust? ›
With an irrevocable trust, the transfer of assets is permanent. So once the trust is created and assets are transferred, they generally can't be taken out again. You can still act as the trustee but you'd be limited to withdrawing money only on an as-needed basis to cover necessary expenses.
How do you distribute assets from an irrevocable trust? ›
The grantor can opt to have the beneficiaries receive trust property directly without any restrictions. The trustee can write the beneficiary a check, give them cash, and transfer real estate by drawing up a new deed or selling the house and giving them the proceeds.
Why do people set up irrevocable trusts? ›
An irrevocable trust is a type of trust typically created for asset protection and reduced federal estate taxes. They are designed so the creator of the trust (the grantor), can designate assets of their choosing to transfer over to a recipient (the beneficiary).
Who manages assets in an irrevocable trust? ›
First, an irrevocable trust involves three individuals: the grantor, a trustee and a beneficiary. The grantor creates the trust and places assets into it. Upon the grantor's death, the trustee is in charge of administering the trust.
Can a beneficiary be removed from an irrevocable trust? ›
A beneficiary cannot be removed from an irrevocable trust by the trustee, but a beneficiary can exit the trust if approved by the other beneficiaries. Beneficiaries can file to remove a trustee if they feel like they are breaching their fiduciary duty. You can be both the trustee and the beneficiary at the same time.
As the Trustor of a trust, once your trust has become irrevocable, you cannot transfer assets into and out of your trust as you wish. Instead, you will need the permission of each of the beneficiaries in the trust to transfer an asset out of the trust.
Who is the beneficial owner of an irrevocable trust? ›
A 'beneficial owner' is any individual who ultimately, either directly or indirectly, owns or controls the trust and includes the settlor or settlors, the trustee or trustees, the protector or protectors (if any), the beneficiaries or the class of persons in whose main interest the trust is established.
What assets Cannot be placed in a trust? ›
What assets cannot be placed in a trust?
- Retirement assets. While you can transfer ownership of your retirement accounts into your trust, estate planning experts usually don't recommend it. ...
- Health savings accounts (HSAs) ...
- Assets held in other countries. ...
- Vehicles. ...
- Cash.
An irrevocable trust cannot be revoked or changed.
Do I have to pay taxes on money from an irrevocable trust? ›
Irrevocable trust distributions can vary from being completely tax free to being taxable at the highest marginal tax rates, and in some cases, can be even higher.
What does Suze Orman say about irrevocable trust? ›
With an irrevocable trust, as soon as the grantor transfers the assets into the trust, they remove all their rights of ownership to the trust and those assets. They can't make any decisions about how the assets should be managed, or if they should be sold.
What is the greatest advantage of an irrevocable trust? ›
An Irrevocable Trust means you can protect yourself, your loved ones and your estate against future legal action. It also means you can protect the financial future of your estate by avoiding substantial estate taxes.
Can the IRS seize an irrevocable trust? ›
The IRS and Irrevocable Trusts
When you put your assets into an irrevocable trust, they no longer belong to you, the taxpayer (this is different from a revocable trust, where they do still belong to you). This means that generally, the IRS cannot touch your assets in an irrevocable trust.
What is the 65 day rule? ›
What is the 65-Day Rule. The 65-Day Rule allows fiduciaries to make distributions within the first 65 days of the new tax year. This year, that date is March 6, 2023. Up until this date, fiduciaries can elect to treat distributions as though they were made on the last day of 2022.
What can you spend money on from an irrevocable trust? ›
What Expenses Can Be Paid for Using the Trust Money?
- Funeral expenses for you.
- Making repairs on your property in the trust.
- Paying your debts.
- Making distributions to trust beneficiaries according to your wishes.
- Hiring professionals to help with administrative tasks.
- Making investments for the trust.
The trustee of an irrevocable trust can only withdraw money to use for the benefit of the trust according to terms set by the grantor, like disbursing income to beneficiaries or paying maintenance costs, and never for personal use.
Who pays taxes on irrevocable trust? ›
One fundamental tax-focused decision when structuring a trust is whether the trust should be a grantor trust or a non-grantor trust. If the former, the grantor will be responsible for paying the income tax on income (including capital gains) produced by the trust assets. If the latter, the trust will pay its own taxes.
Who holds the real power in a trust the trustee or the beneficiary? ›
The trustee is in charge and as a beneficiary you have no control. This is a common misconception. The trustee is administering the trust on your behalf.
Can assets be sold from an irrevocable trust? ›
A trustee can sell property in an irrevocable trust according to the terms provided in the documents used in the creation of the irrevocable trust. Property held in an irrevocable trust is not included in an estate, which means you don't have to pay estate taxes for that property.
Should I put cash in irrevocable trust? ›
CASH : Cash is “safe” to transfer to an irrevocable trust, because there are no negative tax consequences as there are with other assets as discussed below.
What happens to an irrevocable trust when the grantor dies? ›
After the grantor of an irrevocable trust dies, the trust continues to exist until the successor trustee distributes all the assets. The successor trustee is also responsible for managing the assets left to a minor, with the assets going into the child's sub-trust.
What is the 5 year rule for trusts? ›
The five-year rule stipulates that the beneficiary must take out the remaining balance over the five-year period following the owner's death. If the owner died after age 72, the payout rule applies.
Who is the best trustee for an irrevocable trust? ›
Typical choices are the grantor's spouse, sibling, child, or friend. Any of these may be an acceptable choice from a legal perspective, but may be a poor choice for other reasons.
Who is the fiduciary of an irrevocable trust? ›
The trustee is the person responsible for the management of a trust. He or she has a duty of loyalty, known as a fiduciary responsibility, for the beneficiaries of the trust.
How does a beneficiary get money from a trust? ›
The trustee can transfer real estate to the beneficiary by having a new deed written up or selling the property and giving them the money, writing them a check or giving them cash.
When an irrevocable trust makes a distribution, it deducts the income distributed on its own tax return and issues the beneficiary a tax form called a K-1. This form shows the amount of the beneficiary's distribution that's interest income as opposed to principal.
Can an irrevocable trust be changed after one spouse dies? ›
An irrevocable Trust is one that cannot be changed. Generally, it can't be revoked or amended in any way.
Can a beneficiary add money to an irrevocable trust? ›
A parent or grandparent establishes and contributes assets to an irrevocable trust, either during their life or at their death. The beneficiary of the trust cannot establish the trust, nor can he or she contribute their own assets to the trust.
Can assets be seized in an irrevocable trust? ›
When a settlor creates an irrevocable trust and places assets in it, he or she gives up all control over the assets. The trust language specifies that the settlor cannot take assets out of the trust or make any other changes.
Can the beneficiary of an irrevocable trust also be the trustee? ›
The short answer is yes, a beneficiary can also be a trustee of the same trust—but it may not always be wise, and certain guidelines must be followed.
Can IRS come after trust? ›
It doesn't keep them away from the IRS, though; courts have ruled that if the beneficiary doesn't pay his taxes, the IRS can go after the trust assets. The same rule applies to beneficiaries of regular living or irrevocable trusts.
Should a checking account be in a trust? ›
Some of your financial assets need to be owned by your trust and others need to name your trust as the beneficiary. With your day-to-day checking and savings accounts, I always recommend that you own those accounts in the name of your trust.
What kind of trust does Suze Orman recommend? ›
Suze Orman, the popular financial guru, goes so far as to say that “everyone” needs a revocable living trust.
What type of bank account is best for a trust? ›
A Trust checking account makes it easy for your Trustees to pay off debts and distribute inheritances without draining other assets or relying on outside funds. It also makes it easy to track the money going out and its Beneficiaries.
What is the difference between a simple and complex irrevocable trust? ›
Simple and complex trusts differ in how their assets are distributed. Simple trusts are more restrictive about what can and can't be distributed whereas complex trusts are more flexible.
The key difference is that a living trust, or revocable trust, can be revoked, or changed at any time during the trustor's lifetime vs an irrevocable trust is just that, irrevocable, unchanging.
Why would someone want an irrevocable trust? ›
The only three times you might want to consider creating an irrevocable trust is when you want to (1) minimize estate taxes, (2) become eligible for government programs, or (3) protect your assets from your creditors. If none of these situations applies, you should not have an irrevocable trust.
