Irrevocable trusts are legal arrangements used to protect and preserve assets for beneficiaries. This article discusses what irrevocable trusts are and what they do.
What is an Irrevocable Trust?
An irrevocable trust is a legal structure created when a grantor transfers assets or property to a trustee to be held, managed and distributed for the benefit of one or more beneficiaries. Once the trust has been formed, the grantor’s ability to modify the trust agreement, or reclaim the trust assets, is limited. The trust assets are managed for the benefit of the beneficiaries.
How Does an Irrevocable Trust Work?
Once the trust has been created and assets have been transferred to it, the trustee takes over. The trustee is responsible for managing the trust assets and distributing them to the beneficiaries according to the terms of the trust agreement. The trustee is legally obligated to act in the best interests of the beneficiaries and must adhere to the terms and conditions of the trust agreement. Often, the trustee and the grantor are different people. Depending on the type of irrevocable trust, it may not be possible for the grantor to act as trustee without causing adverse tax consequences.
Benefits of Irrevocable Trusts
- Asset protection: Assets placed in an irrevocable trust are generally protected from creditors and lawsuits.
- Tax savings: Irrevocable trusts may help reduce the donor’s future estate tax liability and may provide other tax advantages.
- Flexibility: Irrevocable trusts can be tailored to meet the donor’s specific needs, such as providing for a family member who is disabled or has special needs.
- Control: An irrevocable trust generally allows the donor to maintain some level of direct or indirect control over the assets while they are alive, while also providing for the donor’s beneficiaries after the donor passes away.
Disadvantages of Irrevocable Trusts
- Inflexibility: Irrevocable trusts cannot easily be modified or revoked.
- Certain tax disadvantages: Non-grantor trusts may be taxed at higher federal rates than individuals or other types of trusts.
- Lack of control: Once the trust is created and assets are transferred to the trust, the donor may lose some measure of control over the assets and how they are used. How much control the donor retains depends on the type of trust and how it’s structured.
- Expense: Setting up and maintaining an irrevocable trust can be costly.
Tax Implications of Irrevocable Trusts
Creating an irrevocable trust can have important state and federal tax consequences. For income-tax purposes, there are two general categories of trusts: grantor trusts and non-grantor trusts. Grantor trusts are disregarded for income-tax purposes, while non-grantor trusts are treated as separate taxpayers. Both types of trusts have the potential to save estate taxes. A full discussion of these tax issues is beyond the scope of this article, but the articles linked in this paragraph provide a more in-depth analysis of these issues.
When are These Trusts Used?
Irrevocable trusts can be used for various purposes, such as providing for family members after the grantor’s death, protecting assets from creditors, avoiding probate, transferring assets to a beneficiary in a tax-efficient way, or supporting charity. Valur generates trusts that are geared toward minimizing estate and gift tax, state income tax, and capital gains tax.
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