Irrevocable Trust Definition
Defining what a trust is can be a challenge because so many different kinds exist, many with different rules and requirements. As its name suggests, an irrevocable trust is one that can't be modified, amended, changed or revoked. When you fund property into such a trust, you can’t take it back later. So why would anyone want to create something so permanent?
They do it because an irrevocable trust can achieve a variety of estate planning goals, particularly for larger estates, including reducing or even eliminating estate taxes and providing asset protection for surviving spouses, descendants, and other beneficiaries. Here are the basics of how an irrevocable trust works.
Forming and Funding an Irrevocable Trust
All living trusts are either revocable or irrevocable. When the grantor – the person forming and initiating the trust – creates a revocable trust, he typically acts as trustee and continues to manage the assets and property he places into it. All income earned by the trust is therefore taxed to him personally – he still technically owns the property because he reserves the right to take it back or even eliminate the trust entirely at any time. The value of his trust’s assets count toward his personal estate for determining whether it will owe estate taxes.
The grantor of an irrevocable trust cannot act as trustee. He funds the trust with his assets and steps aside, appointing someone else to manage the property. In return, the trust pays its income taxes. The property the grantor has funded into the trust is no longer his, so it does not contribute to his personal estate. The irrevocable trust typically eliminates any possibility that his estate will owe an estate tax either at the federal or state level. Property held by an irrevocable trust isn't vulnerable to creditors or in lawsuits that might be filed against him personally or the trust's beneficiaries.
Types of Irrevocable Trusts
An irrevocable trust can serve numerous purposes beyond dodging estate taxes. It can be formed with one or more specific purposes in mind.
- A bypass trust accepts the grantor’s property when he dies and holds it for the benefit of his surviving spouse. She can use the property and take income from the trust, but she technically does not own the assets – the trust does. This prevents the property from being included in her estate for tax purposes when she dies. Although the Internal Revenue Code provides for an unlimited marital deduction that allows spouses to transfer their estates to the surviving spouse tax-free, the surviving spouse might otherwise incur estate taxes if she did not remarry and she ultimately passed her estate to a non-spouse, such as her child or another beneficiary.
- A special needs trust can provide for disabled beneficiaries who would lose government benefits were they to inherit outright. The trustee can make certain incremental gifts to the special needs beneficiary so she can enjoy the benefit of the trust's assets without jeopardizing her benefits, again because she does not own the inheritance personally.
- An irrevocable life insurance trust can be set up to accept life insurance proceeds when the grantor dies. Provided that the trust owns the policy, the proceeds do not contribute to the grantor’s estate for estate tax purposes.
- A can be designed to allow beneficiaries to accept income for a period of time before the balance of trust property transfers to a charity. This is called a charitable remainder trust. It can also work the other way around—a charitable lead trust allows a charity to receive income for a period of time before the balance transfers to other beneficiaries. Both have estate and income tax advantages.
Many other types of irrevocable trusts exist—these are just a few of the more common. Speak with an attorney if you have a special concern and you think such a trust arrangement might work for you.
NOTE: State and federal laws change periodically, and the above information may not reflect the most recent changes. Please consult with an attorney for the most up-to-date advice. The information contained in this article is not intended as legal advice, and it is not a substitute for legal advice.