What Is an Irrevocable Trust and How Does It Work?

An irrevocable trust is a legal arrangement where a person (the grantor) transfers assets into a trust and gives up all control and ownership rights to those assets. When assets are transferred into an irrevocable trust, the grantor becomes free of any taxes on that property. And since the grantor no longer owns the assets, he’s protected from creditors and lawsuits.

Key Characteristics of an irrevocable trust 

• It is permanent 

The grantor cannot take back any asset or property that has been transferred into an irrevocable trust.

• Independent control

Since all rights have been conferred to the trustee, he is responsible for managing the trust according to the terms of the trust document. 

• Beneficiaries 

These are the people who are named in the trust document as the recipient of the trust (e.g heirs, charities) and their names cannot be changed.

Benefits of establishing an irrevocable trust

• Estate tax reduction

The assets will no longer be included in your estate. This helps to reduce the size of your estate and the amount of tax you’re expected to pay on your estate.

• Asset protection

Keeping your assets in an irrevocable trust protects you from creditors' claims and legal judgments from lawsuits because the assets are no longer registered in your name.

• Probate avoidance

With your properties in the trust, you can transfer assets to your beneficiaries easily without the hassle of going through the formal court process which can take up so much time.

Drawbacks and considerations 

• Loss of control 

When a grantor transfers his assets into an irrevocable trust, he automatically loses control of those assets. All power has been transferred to the trustee. The grantor has then been removed from the decision making process of selling the assets in the trust.

• Complexity and costs

Setting up an irrevocable trust can be expensive unlike other estate planning tools like wills and revocable trusts. And due to its nature, it can be a complex one too. The cost of an irrevocable trust depends on some factors such as how complex the trust is, your estate size and the attorney’s fees.

Process of creating an irrevocable trust 

• Determining the purpose and specific goals

Before you set up an irrevocable trust, you need to be clear on your goals. Are you setting up the trust to reduce estate taxes, protect your assets from creditors or provide for your kids and loved ones in the future? Whatever your purpose is, you need to be specific about it.

• Selecting a reliable trustee

When setting up an irrevocable trust, you want to choose a trustee who is trusted and reliable. You don’t want to select a trustee who will cause disputes and chaos among the beneficiaries.

• Drafting the trust document with legal counsel

This is an important step in the process that requires the expertise of an estate planning lawyer or a trust attorney. They’re specialized in setting up trusts and know the necessary documents required to set up the trust.

• Fund the trust

You fund the trust by transferring ownership of your asset into the trust so it can manage or distribute them according to your wishes. If you don’t fund the trust, then there’s no property for it to protect.

Selling a house held in an irrevocable trust before death

• Conditions under which a sale is permissible 

The house in the trust cannot be sold if the trustee doesn’t have the authority to sell. It must be stated in the trust document that the trustee can sell the house. Also, the trustee needs the consent and approval of the beneficiaries before they can go ahead and sell the house. 

• Role and responsibilities of the trustee in the sale process

It's the duty of the trustee to ensure that the sale process goes as smoothly as possible. The property can only be sold when the trustee gives the order. The trustee works  closely with the trust attorney to ensure a smooth sale process.

• Distribution and management of proceeds from the sale

The trustee is responsible for distributing the assets in the trust according to the wishes of the grantor. The trustee cannot make any decision that contradicts the instructions in the trust. So, every beneficiary named in the trust must get their share of the proceeds from the sale.

• Tax consequences associated with the sale

The trust pays capital gains tax on the difference between the sale price and the trust’s basis in the property. This means that if the property has appreciated from when it was transferred into the trust, there would be a large capital gains liability.

Conclusion 

When used rightly, an irrevocable trust can be a great tool for protecting your assets, reducing taxes and transferring wealth. You can include this in your financial strategy to protect your estate and pass your properties to loved ones.

The intricacies of an irrevocable trust can be quite advanced especially if you have no prior knowledge. For better understanding, you can work with a financial advisor to gain insight into how irrevocable trust can fit into your financial strategy. They, together with a trust attorney can help you set up an irrevocable trust if you decide that’s what’s best for you.

Frequently Asked Questions (FAQs)

• Can an irrevocable trust be dissolved or amended?

No, an irrevocable trust cannot be dissolved or amended after its creation except in special cases where the beneficiaries consent to it or there’s an unforeseen change that defeats the purpose of the trust.

• How does an irrevocable trust differ from a revocable trust?

An irrevocable trust cannot be changed, modified or amended meanwhile a revocable trust can be changed and the grantor still retains right to the assets in the trust.

• What types of assets can be placed into an irrevocable trust?

Different types of assets can be placed in irrevocable trusts such as real estate, cash, stocks and bonds, life insurance policies etc.

• Are there any income tax implications for beneficiaries?

Depending on how the trust is structured, beneficiaries can face income tax implications for instance, if the trust distributes income.