What is an Irrevocable Trust?
An irrevocable trust, once established, cannot be modified by the grantor or trustee, differentiating it from alterable, revocable trusts.
Irrevocable trusts are trusts that cannot be changed once established. Once the trust’s grantor (the person creating the trust) creates and funds the account, he or she cannot change it by adding or removing beneficiaries or altering its terms. Similarly, the trustee (the person responsible for managing the trust’s assets) cannot make changes to the account. The only person or people who generally have any power to make changes to an irrevocable trust are the beneficiary or beneficiaries of the fund –- and, even then, only under certain circumstances. A grantor can change a revocable trust, but revocable trusts become permanent once the grantor passes away.
One type of irrevocable trust is used for estate planning to help people avoid paying the estate tax. If a grantor establishes an irrevocable trust for a beneficiary (typically a child or grandchild), they can legally give money to that person while they are alive. This policy lets them use their annual tax-exempt gift-giving limit without reducing their estate tax exclusion or giving their descendants full control over the funds. When they pass away, the money in the trust is not considered part of the estate, minimizing the estate taxes they must pay.
An irrevocable trust is like sending a message in a bottle…
When you put a message in a bottle and throw it out to sea, you can’t make any changes to the letter. If you wrote the wrong thing or misspelled a word, it’s too late to do anything about it. Similarly, when you set up an irrevocable trust, you typically can’t make any changes to it, even if you later realize that you made a mistake.
An irrevocable trust‘s terms cannot be changed except in limited circumstances, typically through the courts or with the consent of all involved parties. Once the grantor establishes an irrevocable trust and transfers assets into it, they no longer have any ownership rights to those assets.
Grantors can designate a trust as permanent when they establish it. They can also create a revocable trust, allowing them to make changes to the trust, or to name new beneficiaries if they need to. When the grantor passes away, revocable trusts automatically become irrevocable.
An irrevocable trust works like most other trusts. There are three main parties involved in the trust.
The first is the grantor. The grantor creates the trust, coming up with the rules and terms that they want the trust to follow. They also provide funding for the trust and name the trust’s trustee and beneficiary. In the case of an irrevocable trust, they legally lose ownership of any assets they transfer into the trust as soon as they make the transfer.
The trustee is the person who manages the trust. A trustee has a fiduciary duty to the beneficiary of the trust. That means they have a legal obligation to act in the beneficiary’s best interest. They cannot work for their own benefit when managing the trust’s funds. The trustee has to make sure the beneficiary follows the terms of the trust when making distributions.
The beneficiary of the trust receives the benefits of the trust’s assets. The grantor names the beneficiary when establishing the trust. The trust’s terms dictate whether the recipient receives regular cash payments from the trust or has permission to use the trust’s funds for specific purposes.
Irrevocable trusts are commonly used for estate planning.
One significant benefit of trusts is that the assets in a trust don’t belong to the trust’s grantor anymore. That means that they are not involved in the probate process when the grantor passes away. That leaves a smaller estate for the executor to handle and means the grantor’s descendants will have access to the funds sooner.
Placing money in an irrevocable trust removes the value of those assets from the value of the estate. Because of this, irrevocable trusts can also be used to reduce estate taxes. Grantors can add additional money to the trust each year, up to the gift-tax exclusion amount, to pass money to heirs without paying estate tax.
The most significant disadvantage of irrevocable trusts is that they are tough to change. If you establish an irrevocable trust for a child who later becomes estranged, you have no way of getting the money back. Even if you don’t want to change the beneficiary, you may realize that the terms you set when creating the trust aren’t functioning the way you intended, giving the recipient too much or too little access to the trust’s assets.
Some examples of irrevocable trusts are:
Beyond the fact that irrevocable trusts are far more challenging to change than revocable trusts, the most significant differences between the two types of trust are their legal benefits.
The government tends to consider assets held in a revocable trust as the property of the trust’s grantor rather than that of the beneficiary. That means that revocable trusts offer fewer legal protections. For example, if the grantor of a revocable trust loses a lawsuit, they may have to use the trust’s assets to pay any penalties they incur.
Typically, the beneficiary of an irrevocable trust pays taxes on the money they receive from the trust fund. However, they do not owe taxes on distributions made from the trust’s principal, only from the trust’s earnings.
If the trust isn’t able to distribute all of its earnings to the beneficiaries, the trust itself has to file a tax return. The exact amount that the trust pays varies with the specific type of trust, the assets it holds, and the amount it earns each year.
There isn’t a cost inherent in having an irrevocable trust. Anyone can establish one by filling out and filing the correct paperwork. After creating the trust, the grantor can start adding assets to it.
In most cases, you’ll want help establishing an irrevocable trust. Many financial services companies and lawyers have experience in forming trusts. The cost of working with an expert will vary with the company you hire and the specifics of the account you want to establish.
Irrevocable trusts are popular tools for estate planning, which makes them appealing to many people who wish to qualify for Medicaid. Medicaid has special rules that consider irrevocable trusts when determining eligibility.
To qualify for Medicaid, the recipient must fall below certain Modified Adjusted Gross Income maximums and asset maximums. If you’re applying for long-term Medicaid coverage for assisted living or other long-term help, Medicaid looks at recent asset transfers that you’ve made. This look-back is intended to identify people that gave away assets or sold them below value just to become eligible for Medicaid.
Placing assets in an irrevocable trust could be seen as giving away money to meet the requirements, affecting your eligibility.
The grantor of an irrevocable trust typically does not have the power to sell any real estate that they’ve placed in the trust. Instead, the trustee is responsible for managing the trust’s assets. That gives them the power to buy or sell anything in the trust, including a house.
When establishing the trust, the grantor should have named someone they trust as the trustee. They can speak to the trustee and ask that they sell the home if they want to sell a house that is in an irrevocable trust. If the trustee believes it is in the best interests of the beneficiary, they can take action to sell the house.
A grantor trust is a type of trust where the person forming the trust retains some control over the trust’s assets. In a non-grantor trust, the grantor does not retain control over the trust’s funds. The vast majority of irrevocable trusts are non-grantor trusts.
Grantor and non-grantor trusts have different characteristics. For example, grantor trusts are usually taxed as part of the grantor’s taxes. They’re also included in the grantor’s estate when they pass away, which can impact the estate taxes the grantor’s estate pays.
What are Environmental, Social, and Governance (ESG) Criteria?
Environmental, Social, and Governance (ESG) criteria are standards for investing that enable investors to choose companies based on how well the corporation’s values align with their own.
What is a W-9 Form?
A W-9 is a tax form U.S. businesses use to collect information from independent contractors in order to accurately report payments to the Internal Revenue Service.
What is a Fixed Cost?
A fixed cost is a cost that does not change based on the increase or decrease in a company’s production or sales.
What is Relative Strength Index (RSI)?
The Relative Strength Index (RSI) is a tool that, based on an asset’s recent price changes, helps investors predict whether the price may go up or down in the future.
What is Ex-Dividend?
A stock is ex-dividend when a new owner is not entitled to the next dividend payment — The stock is being purchased excluding a pending dividend distribution, and its price may be slightly lower because of that.