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).
Once established, irrevocable trusts can’t be changed or canceled by the grantor (hence the “irrevocable” in their name). The grantor forfeits ownership and authority over the trust and is unable to make any changes or amendments to the terms of the trust without permission from the beneficiary or a court order. A third-party member called a trustee is responsible for managing and overseeing an irrevocable trust.
Why set up an irrevocable trust?
Assets held in an irrevocable trust generally become exempt from the grantor’s taxable estate. This in turn decreases the grantor’s tax liability (particularly if they have a large estate).
Irrevocable trusts also can avoid probate and are private, meaning the public is not privy to their terms or to the assets held within them.
Types of irrevocable trusts
There are multiple types of irrevocable trusts that one can establish to suit their specific needs and situation.
- A living trust is any form of trust that is established while the creator is still alive. They can be revocable or irrevocable. Establishing an irrevocable living trust just means that the living grantor can’t change or amend its terms.
- Testamentary trusts are set up after the grantor passes away. They are established solely by what the creator has put in their will and are inherently irrevocable because the creator is no longer living and cannot make adjustments to the trust.
- Charitable trusts are established by grantors who wish to not only transfer assets or funds to a beneficiary, but also donate to a charitable organization. This type of trust is also referred to as an irrevocable charitable remainder trust. Through it, a grantor can initially transfer assets to their beneficiary, then subsequently disperse the remainder of the assets to charity. This trust also enables the grantor to take a partial income tax deduction for funding the trust.
- Irrevocable life insurance trusts (ILIT) offer the opportunity to own a partial or permanent life insurance policy during the insured’s life, as well as to oversee and distribute the proceeds of the policy following the insured’s death.
What happens to an irrevocable trust when the grantor dies?
Historically, after a grantor’s death, a beneficiary was permitted to distribute the assets granted to them in an irrevocable trust over the course of their anticipated lifespan.
However, changes made under the SECURE (Setting Every Community Up for Retirement Enhancement) Act have resulted in some beneficiaries in certain scenarios being required to accept the whole sum of the assets ten years after the year of the grantor’s death.
Exceptions to irrevocable trusts
It may sound like the terms of an irrevocable trust are ironclad, but there are instances when a third-party can justifiably overturn your trust.
If you establish and transfer assets and funds into an irrevocable trust while there is an active lawsuit against you, or during a period of time when you are anticipating an impending lawsuit, a court of law may successfully overturn the trust. Basically, it’s not permitted to preemptively establish an irrevocable trust to protect your assets from a specific party.
Additionally, depending on the state, there are certain circumstances that could allow the trustee and the beneficiary to make changes to an irrevocable trust. The trustee might allow the beneficiary early access to the assets due to the onset of a life-threatening illness, for example.
The differences between a revocable and an irrevocable trust
The big difference between revocable and irrevocable trusts amounts to the degree of flexibility each one offers. Unlike irrevocable trusts, revocable trusts allow their creator to alter or dissolve the trust at their discretion (contingent upon their mental competency).
Prior to their death, the grantor of a revocable trust may also reclaim the property and assets within their trust. But upon their death, the revocable trust automatically becomes irrevocable. Finally, any assets or property transferred into a revocable trust are not protected from estate taxes or legal actions.
Important considerations when creating an irrevocable trust
Irrevocable trusts are not exclusive and in fact can be a useful type of trust to consider for anyone in the midst of the estate planning process.
However, setting up an irrevocable trust can be challenging. To ensure the trust is set up according to your desired outcome(s), consult or hire a tax or estate planning attorney to help you in the process.