Irrevocability v. Control
When we talk about an irrevocable trust, we are talking about MANY different types of trusts. Compared to the revocable trust as foundation of basic estate plan, most of the irrevocable trusts are served as a vehicle to achieve more specific estate planning goals. It is a powerful tool especially in the area of tax planning and asset protection planning.
Quite often clients may feel uneasy with the word “irrevocable” because they associate it with the relinquishment of control, inflexibility and rigidity. Many people have missed out on the opportunity to utilize this effective tool because of this misconception.
First, let’s look at the “irrevocability.” “Irrevocable” simply means that you can’t change the trust in its entirety, and generally, the opportunities to amend the trust must be quite limited if the trust is to serve the purposes for which it is created. Irrevocable trusts are often separate entitles for income tax purposes causing the obligation to file a tax return, whereas revocable trusts are not separate taxable entities.
Does this mean you will lose the control of the assets that have been transferred to the trust? Not at all. Quite the opposite, by proper design, the settlor (you) may retain significant control over the asset that are transferred to the trust by writing provisions into your trust documents. Remember, your trust documents dictate what your trustee can and can’t do with the assets. Furthermore, naming the trustee, setting up a trust protector, and/or retaining trustee removal power (thought certain rules must be conformed) also provide great flexibility of control.
Change of Revocability and Irrevocability in Estate Planning
Under many circumstance, some or all of the assets in a Revocable Living Trust will be transferred into an irrevocable trust that is created by the living trust at settlor’s death.
The kinds of irrevocable trusts commonly used in this kind of planning are
- Bypass Trust (or Family Trust);
- QTIP (Qualified Terminable Interest Property);
- QDOT (Qualified Domestic Trust, used in the non-citizen estate planning); and
- Charitable Trusts.
Other frequently used Irrevocable Trusts:
Children’s trust: Everyone has an annual gift tax exclusion of $14,000 per person. This means that you can give $14,000 each year to as many people as you choose and not use up any of your lifetime gift tax exemption or have to pay any gift tax. If the children are minors, it may not be appropriate to make the gifts directly to the children. Instead, gifts can be made to an irrevocable trust for the children, or a separate irrevocable trust for each child. In that trust, you specify the provisions that will govern how, and at what ages, the children will receive the benefits from the trust.
Life Insurance Trusts – These trusts reduce estate taxes by removing the proceeds of life insurance from a taxable estate. Instead, the trust owns the insurance policy. The beneficiary of the policy can be anyone, but the trustee must be someone other than the previous owner of the policy. The grantor cannot have any control over the policy once the trust is made, and the trust must exist for at least three years before the grantor’s death.
Grantor-Retained Interest Trusts (GRATs, GRUTs, GRITs, and QPRTs) – These trusts also reduce estate taxes by removing property from a taxable estate. The trust maker puts property into the irrevocable trust and names final beneficiaries, but retains some interest in the trust for a set amount of time. That interest might be a fixed annuity from the trust (GRAT), a variable annuity (GRUT), trust income (GRIT), or the right to live in the trust property, a home (QPRT). When that set time period is over, the final beneficiaries own the property outright, and the IRS will value the gift at the time of the creation of the trust. The grantor must outlive the terms of the trust, or no savings will be created.
Generation-Skipping Trusts – These trusts are designed to reduce estate taxes for wealthy families. The final beneficiary is a grandchild or group of grandchildren. The child is usually an income beneficiary, but never owns the property, so that the trust property is not subject to estate tax when the child dies. This type of trust is subject to a generation skipping transfer tax.
Assets held in a revocable trust are always available to the settlor and, therefore, are accessible to creditors and potential law suit liabilities. On the other hand, assets held in a carefully drafted irrevocable trust may be considered unavailable. If so, they are not of reach of potential creditors and the plaintiff of a law suit.
People set up irrevocable trusts for a variety of reasons. Prominent among these reasons is asset protection and tax planning. Remember, the effective way to protect your asset is to “control everything, own nothing.”