10 Facts to Know About Irrevocable Trusts

2. But the beneficiaries will pay taxes on it.

When your irrevocable trust distributes income to a beneficiary, they are responsible for paying income tax on it, generally at ordinary income rates. But trusts, unlike individuals, aren’t subject to gift tax, so the trust is permitted to pay out more than the current gift tax limit of $15,000 annually. If the trust itself generates income that remains inside the trust, it will owe income tax on that.

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3. The other chief benefit of an irrevocable trust is asset protection.

The assets in your trust technically do not belong to you, so if you get sued, those assets are beyond the reach of a legal judgment. This can be very advantageous, to take one example, if you are a doctor, or a member of any other profession that is often subject to lawsuits. But be warned that you can’t make fraudulent transfers to the trust; if you’re a doctor and the subject of a malpractice suit, the courts won’t look too kindly if you transfer a million-dollar asset to the trust in the midst of your trial.

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4. All of these benefits only work if you’re not the trustee of your irrevocable trust.

It’s legally acceptable for the grantor to serve as the trustee for his or her own trust. But if that’s the case, you would be assumed to still have control over the assets within it. That means you would lose the estate tax benefits, the asset protection, etc. Most people instead name a responsible relative or trusted associate to be the trustee. You can never change the trustee, but you can make arrangements for a successor trustee to take over if the original trustee becomes unable to fulfill his or her duties. If appointing someone else to have control over your assets gives you pause, you may want to look into a revocable trust instead.

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5. An irrevocable trust is not completely irrevocable.

You yourself as the grantor can not make changes to it unilaterally, but your trustee can. If you anticipate that changes may need to be made, your trust documents can designate a trust protector, who can make certain changes to it. Many states have adopted regulations allowing changes to the administrative aspects of a trust, like investment provisions or trustee provisions, although usually not the specific interest of the beneficiaries. A court also has the power to make changes to a trust.

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6. Your irrevocable trust can buy and sell property.

One thing that is changeable even in an irrevocable trust is the assets that it holds. If you’ve put a house into the trust, you can sell the house, as long as the proceeds from the sale go right back into the trust. The trust is also responsible for the taxes on any profits from the sale. But you can request, for instance, that the trustee use the proceeds from selling a house to buy a different house.

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7. You can also change an irrevocable trust through an asset swap.

You might find yourself wanting to buy back an asset from your trust, without having that asset revert back to your estate on the time of your passing. There can be real tax advantages to such a swap. If the trust holds an asset that has become highly appreciated, you can swap cash for the hard asset, and the basis on which the asset’s capital gains is calculated will get reset to its fair value. This will eliminate any capital gains on a later sale of the asset.

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8. But you have no direct control over any assets in your irrevocable trust.

If you find yourself in need of income, you do not have the power to sell your assets to produce personal income. For this reason, you should make sure that there is enough wealth being generated outside the trust to keep you comfortable for the remainder of your life.

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9. Transferring assets to an irrevocable trust can help you maintain your eligibility for government programs.

There are income and asset limitations that determine who is eligible for Medicaid and Supplemental Security Income. Assets and income that are sheltered in an irrevocable trust do not count toward these limits. You’ll need to get out in front of this, though: Medicaid has a “look-back period” of five years, so if you transfer a substantial asset to your trust within five years of applying, you may not be accepted.

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10. Be careful: Not every irrevocable trust can satisfy each of these goals.

In fact, you might find it hard to establish an irrevocable trust that meets all your needs. A trust that protects you from estate taxes may not give you the asset protection you need, or preserve your eligibility for Medicaid. In that sense, your client should consult with an estate attorney to build the irrevocable trust that will suit their needs, and will establish the kind of legacy they want to leave behind.

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