Irrevocable Trusts: What to Know

Trusts are often an integral part of many estate plans. In short, this is because they allow you to protect your assets and transfer them to loved ones or causes and charities you care about. And though there are various sub-sets of trusts, there are generally two overarching kinds: revocable and irrevocable.

In this article, we’ll offer an overview of irrevocable trusts and, including insights from Alexander M. Evans, estate planning attorney at Turke & Steil, LLP, explain the benefits and advantages of setting them up. We’ll also discuss their distinction from revocable trusts and answer frequently asked questions surrounding the subject.

What Is an Irrevocable Trust?

An irrevocable trust is an arrangement where you hand off assets to a trustee — an individual or organization — who will manage and maintain them. Eventually, the contents of the trust will pass to one or more beneficiaries named as part of your estate. Often, these may be family members, such as your spouse, siblings, children, or grandchildren.

As one may notice from its name, a key factor about irrevocable trusts is that you can’t change or cancel them after their creation. The terms you put in place upon establishing the arrangement, including who will receive your assets, when, and at what proportion, are fixed and become out of your hands to modify. According to Evans, this involves “permanently [transferring] assets into the trust, relinquishing ownership and control.”

But because irrevocable trusts are permanent, an important benefit is that the assets they house can avoid being targets of litigation by creditors, former spouses, or others. They also avoid probate, ensuring your investments and funds can go to who you want as easily as possible without passing through a lengthy and arduous legal process.

Distinction from Revocable Trusts

As mentioned, irrevocable trusts are one of two main forms of trusts available in estate planning, along with revocable trusts. The primary difference between the two is that while irrevocable arrangements are permanent, you can walk back or modify the other type to fit life changes. While this provides some flexibility in managing your finances and estate plans, this could leave the assets vulnerable to taxes and creditors.

“Unlike a revocable (or living) trust, which can be altered or revoked during the grantor’s lifetime, an irrevocable trust is generally set in stone once created,” explains Evans. “This distinction is crucial because it determines how much control you retain over the assets and how they are protected from creditors and estate taxes.”

Why Establish an Irrevocable Trust

Establishing an irrevocable trust can be effective for many reasons, including its ability to help reduce the estate’s tax burden, protect your assets in certain situations, and plan for health benefits, such as Medicaid. Below is a more detailed breakdown of the advantages you could get with a permanent trust:

Lowering Estate Taxes

A critical reason to place assets in an irrevocable trust is that it can lower the taxes the estate will incur after you pass. When the assets transfer to beneficiaries, those included in a revocable trust may be prone to estate taxes. Evans explains, however, that an irrevocable arrangement “can help reduce the taxable value of an estate, potentially saving heirs significant amounts in estate taxes.”

As a grantor transferring assets to a trustee permanently, you no longer have access to or direct ownership over them. Evans says, “This saves on estate taxes especially with appreciating assets as their value is fixed and any appreciation would take place outside of the Grantor’s estate.”

It’s important to note, though, that there are many different forms of irrevocable trusts. This can mean that tax treatment and benefits can vary by your situation and arrangement.

Asset Protection

Another advantage irrevocable trusts carry is a heightened level of asset protection for your estate. In some cases, you could find your assets as a target of creditors, lawsuits, or former spouses. However, when you place funds into a permanent trust, they are no longer technically yours but rather owned by the trust. Because they’re inaccessible to you, they’re also unavailable to third parties who may come after your wealth.

“Once the assets are transferred into the trust, they are no longer part of the grantor’s estate and are therefore shielded from creditors, lawsuits, and certain legal judgments,” says Evans. “This level of protection is particularly beneficial for individuals with significant assets or those in professions with high liability risks, ensuring that their wealth is preserved for their beneficiaries,” he adds.

Implementing an asset protection strategy via irrevocable trusts can be helpful, as Evans mentions, for individuals with more money and those who draw more risk from their occupation, including business owners, doctors, nurses, and attorneys.

Avoiding Probate

Placing assets in a trust also allows you to circumvent probate. Because the trustee manages the assets with a defined plan to disburse to named beneficiaries, they can avoid the lengthy and public legal process of discerning who gets what. In that way, you can streamline the execution of your estate and keep it in-house.

Medicaid Planning

Finally, according to Evans, irrevocable trusts “play a key role in qualifying for Medicaid by sheltering assets from being counted toward eligibility limits.” In other words, like taxation and asset protection advantages, the funds you place in a permanent trust arrangement don’t count towards your net worth. Therefore, you can use it to plan how much money to stow away to qualify for medical benefits such as Medicaid.

Disadvantages to Consider

Though irrevocable trusts have valid advantages for asset protection and lowering estate taxes, they have drawbacks. Most notably, this includes irreversibly delegating control of your assets once you establish the trust. While this locks down your funds and investments to pass on to future generations, it can be unnerving to no longer have access to a large sum or portion of your portfolio, especially if you end up needing it in the future for any reason.

Another disadvantage of creating an irrevocable trust is that “the setup and ongoing management can be complex and costly,” per Evans. Specifically, you may need to pay an expert to help decide how it fits into your unique estate, likely a legal professional to draft up the documents, and a trustee to manage the assets. Therefore, it’s often an option primarily for individuals and families with a high net worth to protect.

While both the costs and the permanent nature of irrevocable trusts are pitfalls from the grantor’s standpoint, Evans observes that a “less-discussed downside is the potential tax implications for beneficiaries.” In particular, he notes, they “might face higher tax rates on income generated by trust assets.”

Frequently Asked Questions

Can you change an irrevocable trust?

It can be possible to amend the terms of an irrevocable trust, but Evans points out that this can prove difficult “as changes typically cannot be made without the consent of the beneficiaries or court approval.” In other words, before any change is possible, it’s customary to discuss them with and get a sign-off of approval from beneficiaries or get a court order.

Which is better, a revocable or irrevocable trust?

The answer to this question ultimately depends on your needs while planning your estate. If you want more protection from creditors or litigation and value reducing taxes, an irrevocable trust may be an option. On the other hand, a revocable trust may be more valuable if you prefer more flexibility and control over your assets during your lifetime.

To decide which type of trust is right for you, we recommend consulting the expertise of a financial advisor or estate planner. To find one, you can use this free matching tool that will connect you with an expert who fits your needs.

Are there different types of irrevocable trusts?

There are many sub-types of irrevocable trusts, each with unique functions and advantages. As an estate planning professional, Evans named these six as some of the most common he deals with:

• Irrevocable Life Insurance Trust (ILIT)
• Grantor Retained Annuity Trust (GRAT)
• Qualified Personal Residence Trust (QPRT)
• Dynasty Trust / Generation Skipping Trusts
• Charitable Remainder Trust (CRT)
• Irrevocable Trust for Education or Special Needs

How does it work to set up an irrevocable trust?

Setting up an irrevocable trust is a relatively straightforward process. It involves, at the most basic level, drafting documents, finding a trustee, naming beneficiaries, and allocating assets to the trust. However, while there aren’t too many surface-level steps, it can be complex, especially if you have a multi-layered portfolio with unique needs. Therefore, having a professional by your side while establishing a trust is vital. They can walk you through each step and explain how the arrangement will fit into the larger context of your estate and financial plans.