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What is an Irrevocable Trust and how is it set up?

By James

As the name suggests, an irrevocable trust is one that cannot be revoked, changed or amended once it has been set up. People usually set up an irrevocable trust in order to reduce taxes. They may also set one up in order to protect their property against lawsuits, creditors, and even divorces. Once you fund your property into an irrevocable trust, you cannot take it back later on. Although there are different kinds of Trusts one can choose from, the rules and requirements of the trust define the kind of trust it is. Read on to understand how irrevocable trusts are structured and what benefits they can provide.

Parties involved in an Irrevocable Trust

There are 3 key players typically involved in an irrevocable trust:

  • The Grantor – The person who creates the Trust
  • The Trustee – The person who administers the Trust
  • The Beneficiary or Beneficiaries – Those who are entitled to receive benefits of the trust

The terms and conditions of a Trust are established and laid out in a Trust agreement in writing. This agreement sets forth the role of each individual and also describes how the trust property will be managed and distributed. The trust agreement is executed in agreement with the state laws and is generally drafted by a Trusts Attorney.

Planning for an irrevocable trust

An irrevocable trust needs to be carefully planned and thought out. The following is an overview of some of the steps that need to be followed:

  • Choose a trustee
  • Prepare an irrevocable trust agreement
  • Obtain a Taxpayer Identification Number for the trust from the IRS (Internal Revenue Service)
  • Check your state laws for any specific requirements
  • Transfer the assets into the trust

Why would someone want to set up an irrevocable trust?

As already mentioned, an irrevocable trust is a permanent trust, which means that if something has been put it that trust, it cannot be taken out. This is done to achieve a number of estate planning goals. Irrevocable trusts are particularly used for large estates, and the trust helps to reduce or eliminate estate taxes. The irrevocable trust also provides asset protection for surviving spouses, children, descendants and other beneficiaries.

How do Trusts work?

There are two types of trusts: revocable trust and irrevocable trust. When the person forming and initiating a trust, also known as the grantor, creates a revocable trust, he or she typically acts as a trustee and continues to manage any assets and property he puts into the trust. Any income earned by the trust is taxed to the grantor personally. Even though the property has been added to the Trust, the grantor is still the technical owner of the property. The grantor reserves the right to take back the property at any time or eliminate the trust entirely.

However, that is not the case with an irrevocable trust. In case of an irrevocable trust, the grantor cannot act as the trustee of the trust. After funding the trust with his assets, he steps aside and appoints a trustee to manage the property. The trust pays its income taxes in return. The irrevocable trust also eliminates any possibility that the estate will owe any estate tax. Moreover, property held by an irrevocable trust is not vulnerable to lawsuits that may be filed against the beneficiaries of the trust or creditors.

Different types of Irrevocable Trusts

Apart from dodging estate taxes, an irrevocable trust can also serve numerous other purposes. Read on to understand the purposes for which an irrevocable trust may be set up:

Bypass trust – This type of trust accepts the grantor’s property after he dies and holds it for the benefit of his surviving spouse. The spouse can use the property as well as take income from the trust. The property is technically owned by the trust and not the surviving spouse. The spouse can only use it and take income from the trust.

The purpose of a bypass trust is to avoid that property from being included in the estate of the spouse for tax purposes after she dies. Even though the IRC provides for an unlimited marital deduction that allows spouses to transfer their estates to their surviving spouse tax-free, the surviving spouse may end up incurring estate taxes if she did not remarry and ultimately passed on her own estate to a child or beneficiary.

Special needs trust – The purpose of this kind of trust is to provide for disabled beneficiaries who would lose government benefits if they were to inherit outright after the passing of their parents. The special needs beneficiary can be given incremental gifts by the trustee in order to enjoy the benefits of the trust’s assets. This does not jeopardize the benefits of the beneficiary as he or she does not own the property personally.

Irrevocable life insurance trust – This kind of trust can be set up to accept life insurance proceeds after the grantor dies. Proceeds from the trust do not contribute to the grantor’s estate for estate tax purposes, as long as the trust owns the policy.

Charitable trust – Such a trust is set up to allow beneficiaries to accept income from the trust for a certain amount of time, before the trust property is transferred to a charity. When it works the other way round, the charitable lead trust allows a charity to receive income for a certain period of time before the balance transfers to other beneficiaries. Both kind of trusts, the charitable remainder trust and the charitable lead trust, have income tax and estate advantages.

Apart from the above listed types, many other types of irrevocable trusts exist. For more details on how a trust works and if a trust arrangement might work for you, talk to a lawyer.

Even through an Estate Planning attorney might seem expensive at first, the thing to know about an Irrevocable Trust is that the trust will pay off the attorney costs in the long run. Irrevocable Trusts are designed to protect your hard earned money and other assets for your loved ones, whom you care about the most. An irrevocable trust can also significantly reduce the estate’s exposure to estate taxes as these legal arrangements are used for tax-sheltering. So contact an estate planning attorney in your area to discuss the right option for you.

Author Bio:

Experience Rhode Island Personal Injury Attorney, Simone & McCahey LLP.

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