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What Is an Irrevocable Trust?

What is an Irrevocable Trust? An Irrevocable Trust is an estate planning tool that has many applications in preparing and preserving your personal estate. As the name indicates, you cannot make modifications to the trust – hence the “irrevocable” title. You can think of an irrevocable trust as a basket that you place your assets in. You do not have access to anymore – essentially the lid is closed. 

There are a few benefits over and above what a Revocable Trust offers the originator. While it is true that you cannot make any changes, the potential tax benefits may outweigh this point. Irrevocable Trusts are more complex than Revocable Trusts. The tax implications alone could require professional assistance when arranging the framework of the trust. 

Benefits of an Irrevocable Trust

An Irrevocable trust provides many benefits to your estate planning needs. Most of these are beneficiary related, as the originator gives up access to the account upon creation of this trust. Some of the main benefits of an Irrevocable Trust are:

  • Removes taxable assets from your property and takes advantage of the estate tax exemption
  • Property transferred to the Irrevocable Trust removes the assets from your value of the estate — improving your tax situation
  • You gift children or other beneficiaries under a more favorable tax condition
  • You can control assets post-death if you suspect your heirs will misuse funds
  • Can avoid estate taxes upon any insurance distributions 

How To Start an Irrevocable Trust?

Whether you have a modest amount of assets, or you are extremely wealthy (or somewhere in between). you may need help getting started. An irrevocable trust has more nuances than a revocable trust, and therefore may require professional assistance in creating one. Some things you should typically gather prior to getting started are as follows:

  • Asset inventory — could be bank accounts, life insurance, real estate properties, etc.
  • Assign someone to be your trustee to manage your trust
  • Designate your heirs or beneficiaries for all assets

After all information is gathered, it is suggested that you work with a financial advisor or an estate planning attorney. They can guide you through all of the appropriate steps. 

Types Irrevocable Trusts

There are many types of irrevocable trusts that you can use depending upon your estate planning needs. Some of the most common types are as follows: 

Testamentary Trust

A Testamentary trust is created by the will, and it comes into existence when the person making the will passes away. It is a provision within a will that names the executor for the estate as well as instructs this person to create said trust. After the person’s death, it has to go through the probate process to determine the legitimacy of the will. From this point, the trust is realized and assets and property is transferred to the decedent’s estate. 

A testamentary trust can:

  • Potentially reduce tax liabilities paid by the beneficiaries from the income from the inheritance
  • Can provide a higher level of control and flexibility over the asset distribution to all beneficiaries 

Life Insurance Trust (ILIT)

This type of trust is often referred to as an “ILIT”, or an “Irrevocable Life Insurance Trust”. This is a trust that you designate to hold any life insurance policies that you have. The payout of the policy goes directly to your trust when you die. This happens since the trust is the main beneficiary on the insurance policy. The advantage of this kind of trust is that it lets you circumvent estate taxes on distributions from the life insurance policy.   

Qualified Terminable Interest Property Trust (QTIP)

You can transfer your personal residence to a qualified personal residence trust (QPRT), and still, live in your house for many years. The biggest reason for this type of trust is for gift tax purposes. The interest in the property that is retained reduces the current value of the asset – a gift to the trust. The appreciation on the property is removed from the estate after the transfer.  

Bypass (Credit Shelter) Trust

A bypass trust, is created by married couples to reduce estate taxes for their heirs. This type of irrevocable trust transfers the specified assets directly from one spouse to the surviving spouse. The terms are outlined within in the trust. The surviving spouse maintains certain rights over the course of their lifetime with a credit shelter trust. 

The assets are never really in the control of the surviving spouse. Instead, they are managed by the trustee of the trust. This is known as a bypass trust, since essentially you are bypassing the taxes. Taxes are not added to the surviving spouse’s estate.     

Charitable Trust

A Charitable trust lets you to designate a charity or charities as beneficiaries upon your death. There are two types of charitable trusts, the charitable remainder trust and a charitable lead trust. 

The Charitable Remainder trust provides you with access to your assets for a period of time., After that allotted time, all of the left over assets will be transferred to whichever charity you choose.

The Charitable Lead trust lets you designate an amount that you would like to pass along to a  charity of your choice. At the same time, you are still able to pass the remainder of the estate to your beneficiaries. 

Revocable vs Irrevocable Trusts

The main difference between a Revocable and Irrevocable Trust is that you are allowed to make changes to one, and not the other. With a revocable trust, you are able to make updates as necessary throughout your lifetime. The opposite is true of an irrevocable trust, you can absolutely not make changes to the trust without the approval of the beneficiaries. This means that assets within an Irrevocable Trust are essentially not yours anymore.

You may be thinking which one would be best for me? What are the main differences between the two types of trusts that I should be mindful of? 

With an Irrevocable Trust, the benefits are mentioned above. To recap though, the assets placed in the trust are removed from the taxable estate. This means no estate tax upon death. This is basically a tax shelter for any earnings it accumulates. On the flip side, the main downside with an irrevocable trust is that the originator cannot touch the assets once they are placed within the trust.

With a Revocable Trust, some of the main benefits are that you are able to update, modify, or completely revoke this at any time. You avoid the probate court process, and are FDIC insured to a certain point as well. Some of the main hindrances of a revocable trust are that since the assets are not frozen. It does not provide shelter from creditors, and also you are susceptible to being sued. Also, the estate becomes taxable at the state and federal levels when the originator of the trust dies. 

Irrevocable Trust vs Will?

How does an Irrevocable Trust compare to a will, and why is it important that you should have both? We have a good understanding of the importance of an Irrevocable Trust, but how does this compare or even relate to a will

An irrevocable trust cannot be modified after it is set up, the assets are essentially passed off at this point. This trust is where you should place all of the valuable and important items, such as real estate, investments, etc. The trustee will then handle your affairs as they have been laid in the trust. This helps avoid probate and court systems, saving you time and money. 

You handle more so the personal items that you wish to pass on with a will. The most important inclusion in your will should be the person you wish to have guardianship of your children. That is, if you leave any behind. If you want to keep the courts out of the decision making process, you must have a will to designate who shall be the primary caretaker. 

Also, anything that you want to go to specific people, you should document in a will. This can be property for children, parents, siblings, friends, etc. Examples of items that could be included in a will are art, computers, family pets, jewelry or other heirlooms, furniture, any personal belongings. 

Final Thoughts: Start Planning Your Estate

It’s imperative to have both a trust and a will to properly plan your estate and protect your loved ones. An irrevocable trust is effective for many reasons. As long as you are comfortable with not having control over the trust while you are still alive. 

Most financial planners suggest to have both a trust and a will. Wills are needed in addition if you have minor children especially. Also it is needed if you wish to pass along certain personal belongings to specific individuals. 

Setting up a will can be accomplished via several methods, some are free and some have an associated fee. This depends on the route you wish to go. Depending upon the complexity of your financial situation, working with a financial advisor may be the best way forward. This is especially fruitful if you wish to set up an Irrevocable Trust. It is often intricate and could use a professional set of eyes to review and organize.