A Primer on Irrevocable Trusts

How do irrevocable trusts fit into my estate plan?

Although many people think that estate planning is only about creating a will, a comprehensive plan considers a number of objectives such as asset protection, avoiding probate, and minimizing estate taxes. One effective tool for achieving these goals is an irrevocable trust.

What is an Irrevocable Trust?

An irrevocable trust becomes effective during a person’s lifetime and, unlike a living trust, cannot be amended or modified. In short, the grantor (the person making the trust) permanently relinquishes ownership of property by transferring it into the trust. In this arrangement, a trustee is named to manage the trust assets for the benefit of the beneficiaries.

There are a number of advantages to creating a irrevocable trust. First, the trust property is not subject to estate taxes. Further, unlike a will, a irrevocable trust is not required to go through probate, which saves time and money and maintains the privacy of the financial arrangements. Finally, if the trust is designed properly, the assets will be protected from creditors.

Types of Irrevocable Trusts

There are a variety of irrevocable trusts, including:

  • Bypass Trusts –  Typically utilized by married couples with assets above the federal exemption amount (currently $10.9 million). In a bypass trust, property of the spouse who dies first is transferred into a trust for the benefit of the surviving spouse. Since that spouse does not own the property, it does not become part of his or her estate and is not subject to estate taxes.
  • Charitable Trusts – Designed to reduce the grantor’s income and minimize estate taxes by combining gifting with charitable donations.  By way of example, a charitable remainder trust is one in which the grantor transfers property into a trust and names a charity as the final beneficiary. After another individual receives income generated by the trust for a specified period of time, the remaining assets are distributed to the charity.
  • Life Insurance Trusts – The proceeds of life insurance pass outside of an estate, however, they are included in the estate’s value for tax purposes. By transferring ownership of the policy into a trust, the proceeds are removed from the estate thereby minimizing estate taxes.
  • Spendthrift Trusts – Specifically designed for those who have troubled heirs such as those who are incapable of managing their finances, have a history of not paying debts, or have drug, alcohol or gambling issues. In this arrangement, a trustee is named to manage the funds and purchase goods and services for the beneficiary, make payments directly to landlords and creditors, or distribute proceeds to the beneficiary.
  • Special Needs Trusts – Because those with special needs often rely on public benefits such as Medicaid, Medicare or Social Security Disability, an inheritance could disqualify these individuals from receiving these benefits. This type of trust allows funds to set aside to provide for day-to-day expenses of a special needs person while preserving his or her eligibility for benefits.

The Takeaway

In sum, irrevocable trusts are important estate planning tools that achieve a number of financial objectives. Nonetheless, creating a properly designed trust requires the advice and counsel of an experienced trusts and estates attorney.