The irrevocable trust is one of the most common tools in asset protection planning. However, the irrevocable trust often is misunderstood, and for many people, the term “irrevocable” causes apprehension.
A trust is a legal entity that holds property on behalf of the grantor – the person giving the property – for the benefit of the beneficiary, who is the person receiving the property. An irrevocable trust specifically refers to a type of trust instrument that cannot be altered, amended or revoked – with some exceptions.
Although there are many variations of irrevocable trusts, one of the most common is the Intentionally Defective Grantor Trust. That is a long term that simply means the grantor retains the tax benefits of trust property as well as asset protection.
Irrevocable trusts are used to set aside assets for legacy planning. Placing property into an irrevocable trust ensures the property cannot be taken by long-term care costs, future creditors or lawsuits. Some people set property aside to guarantee an inheritance to loved ones, while others simply want to ensure they never will be left destitute, even if in long term care.
The benefits of using this type of trust are significant. First, IDGTs are tax-advantageous for grantors. These transfers remain “defective” gifts so the grantor can continue to include any trust income on his or her own personal taxes. The tax rates for completed gift trusts are much higher than ordinary individual income tax rates, so keeping the transfer intentionally defective protects the much lower tax rate.
Second, IDGTs are tax-advantageous to beneficiaries. When beneficiaries receive property during the grantor’s lifetime, the transfer is a gift, as if the grantor had transferred it himself. However, after the grantor has died, beneficiaries receive the property with a fresh tax basis of the value at the time of the grantor’s death, which can result in significant capital gains savings.
This tax savings is the same that a beneficiary would have if he inherited the property through the grantor’s last will and testament, but without risk of creditor claims.
Of course the greatest benefit of using irrevocable trusts is creditor protection. By placing property into an entity with limited control left to the grantor, the property is protected against claims against the grantor. This protection extends to long term care, which can result in much faster Medicaid qualification without complete exhaustion of the grantor’s property.
Although many people recognize the benefits of using irrevocable trusts, there are three main frequently asked questions: whether beneficiaries can be changed, whether changes can be made to reflect tax updates and whether the grantor can take property back if later needed.
First, grantors generally retain a limited power of appointment, which allows them to make changes to beneficiary designations.
Second, legal and tax changes can be accomplished through the use of a trust protector, a neutral third party that can sign off on necessary revisions so long as they continue to follow the grantors’ purposes in the instrument.
Third, most goals can be completed within the trust rather than removing and replacing assets. For example, if grantors choose to sell a house and purchase a smaller house, the sale and purchase can be completed within the trust. However, if a removal of assets is necessary, the trust can gift property to the grantor’s lifetime beneficiary, who can then gift the property to the grantor or simply pay the grantor’s expense.
Irrevocable trusts are powerful tools for asset protection and legacy planning. IDGTs particularly are tax advantageous and can ensure that lifetime and after death goals are met, despite unexpected lawsuits or long-term care costs.
This article originally appeared on The News-Enterprise.
