If you’ve explored the basics of estate planning, you’ve probably found information regarding irrevocable trusts, and with good reason. Irrevocable trusts remain an excellent tool for protecting your assets, providing for your family when you’re gone, and much more. The information below will help you understand a little more about what an irrevocable trust is (and what it isn’t), the types of irrevocable trusts, who should consider one, and more.
What is an Irrevocable Trust?
As you might expect from its name, a revocable trust allows a grantor (the person forming the trust) to modify or revoke it. Transferring additional assets and removing existing assets are also easy to do with a revocable trust. However, revocable trusts don’t provide any tax benefits or creditor protection.
This differs significantly from an irrevocable trust. In general, you cannot change or revoke an irrevocable trust without the agreement of each beneficiary, or court involvement. Assets may be added to an irrevocable trust at any time, but removing them from the trust can be a more complicated issue. So, what value is there in creating a trust that you cannot modify or revoke after you’ve formed it? Generally, irrevocable trusts are set up to minimize estate taxes, access government benefits, and protect assets from creditors and judgments in our litigious society.
What Are Some Important Things to Know About Irrevocable Trusts?
Irrevocable Life Insurance Trusts. Most people don’t know that life insurance can be subject to estate taxes (it is not subject to income taxes). If you transfer the ownership of your life insurance policy to an Irrevocable Life Insurance Trust (ILIT), and you also name the trust as the beneficiary of the policy, the death benefit—no matter how large it is—will pass to the ILIT, and subsequently to the beneficiaries you designated in the ILIT, tax-free.
Special Needs Trusts. If you have a loved one with special needs, you should place all assets you want them to inherit in a special needs trust. If the desired beneficiary is receiving (or might apply for) needs-based government benefits to help with their special needs, leaving an inheritance directly to the beneficiary can destroy those benefits. Then, after the beneficiary is forced to spend down the entire inheritance, it can take them a long time for them to qualify for benefits again. A special needs trust is an irrevocable trust that bypasses this issue and provides for the financial security of an individual with special needs. In essence, the beneficiary can continue to receive their government assistance and have the benefit of the full inheritance left to them in the special needs trust.
Qualified Income Trusts. Medicaid applicants who have income over Medicaid’s limit may direct income into irrevocable Qualified Income Trusts (also called by many other names, including Miller Trusts, Qualifying Income Trusts, QITs, Income Diversion Trusts, Income Cap Trusts, Irrevocable Income Trusts, Income Trusts, d4B trusts, and Income Only Trusts) to become eligible for Medicaid long-term care. In short, any income over Medicaid’s limit is put into a trust and therefore not counted as income, thus allowing the applicant to become eligible.
Qualified Personal Residence Trusts. A qualified personal residence trust (QPRT) is a specific type of irrevocable trust that removes a personal home from your estate to reduce the amount of gift tax that is incurred when transferring it later to a beneficiary. The owner of the residence continues to live on the property for a period of time with “retained interest” in the house. When that period is over, the “remainder interest” is transferred to the trust’s remainder beneficiaries. The value of the retained interest is calculated based on applicable federal rates established by the Internal Revenue Service. Because the owner retains a part of the value, the gift value of the remainder interest is lower than its fair market value, thus lowering the gift tax. The risk lies in choosing the termination date of the trust agreement because there is a possibility the grantor will pass away before that date. The longer the trust exists, the smaller the remainder interest attributed to the beneficiaries, which in turn reduces the gift tax.
Charitable Trusts. With charitable trusts, you can donate assets to your favorite tax-exempt charitable organization or nonprofit and reduce your taxes. Charitable trusts can provide an income stream to you and your beneficiaries for a defined period. They also are a strategy for having a significant effect on a cause you deeply value. However, you will have to choose from more than one type of charitable trust.
A charitable lead trust is an irrevocable trust that distributes income to charities or nonprofit organizations for a set number of years. You may receive income from the trust, deductions for gift and estate taxes, and income tax deductions for the tax year in which you donate assets to the trust. When the charitable lead trust terminates, the assets remaining in the trust revert back to you, your heirs, or other beneficiaries you designate. The remaining assets do not have to go to the charity.
A charitable remainder trust (CRT) operates differently than a charitable lead trust. A CRT is an irrevocable trust funded with cash or securities. The CRT provides income to you or other beneficiaries, but the remaining assets in the trust revert to the charity upon your death or the termination of the trust. There are two types of CRTs: A charitable remainder annuity trust (CRAT) distributes a predetermined amount as an annuity every year; no additional contributions can be made to a CRAT. On the other hand, a charitable remainder unitrust (CRUT) distributes a fixed percentage of the value of the trust, which is recalculated annually. Additional contributions are allowed to a CRUT.
Why Should I Get an Irrevocable Trust?
When you establish an irrevocable trust, you create a vehicle for assets to transfer to a third-party beneficiary. There are numerous benefits to this strategy, including:
- Positioning assets to help your family members well into the future
- Protecting your assets from liabilities and creditors
- Reducing estate taxes
- Creating a legal framework for predictability if you get sick
- Ensuring that your loved ones receive the care they need
- Giving you the peace of mind that comes with excellent estate planning
If you’re thinking of getting an irrevocable trust, it’s essential that you work with a qualified attorney who will walk you through the process to ensure government compliance and excellent benefits.
An Experienced Attorney Can Help Guide You Through the Process
The skilled and experienced attorneys at Anderson Estate Planning are here to help. We know estate planning can be challenging to think about or discuss, so that’s why we handle every step of the process for our clients. Contact us today and let us help you get started.