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Revocable Trusts

Irrevocable Trusts – Pros & Cons

What is an Irrevocable Trust?

In essence, all trusts are relationships whereby property is held by one party for the benefit of another.  The trust’s creator, called a “Settlor”, transfers some or all of their property to a “Trustee”, who holds that property for the trust’s “Beneficiaries”.

In contrast to Revocable Trusts, Irrevocable Trusts are permanent transfers of assets to a separate entity: The Trust.  When you set up an Irrevocable Trust, you forgo all rights for all time to the property or assets that are transferred to the Trust.  An Irrevocable Trust cannot be amended, altered or changed once it is established, so you cannot change your mind and redistribute trust assets or proceeds once it is established.  Because they are treated as entirely separate entities, Irrevocable Trusts are taxed as separate entities on their accumulated income.

Although in rare cases a court may change the terms of the trust due to unexpected changes in circumstances, under normal circumstances an Irrevocable Trust may not be changed by the Trustee or the Beneficiaries of the trust.

Why are Irrevocable Trusts used?

Irrevocable Trusts are primarily used in estate and tax planning scenarios.

You can use Irrevocable Trusts to permanently transfer assets away from your own estate, and thus avoid estate taxes or paying income taxes on the assets. Irrevocable Trusts are also utilized in order to reduce your own tax liability and split income among family members to further minimize tax liability.

In addition, Irrevocable Trusts also provide asset protection for any assets transferred to the Trust, as assets in Irrevocable Trusts cannot be seized by creditors or as part of a legal action.

Pros

  • Once one transfers their assets to an Irrevocable Trust, then the taxes on their estate are reduced as those assets will no longer be included in their personal assets.  Thus, people with large estates benefit most from Irrevocable Trusts; those who fall into the middle class and lower upper class may find Irrevocable Trusts not to be worthwhile, however.
  • By creating an Irrevocable Trust, one’s assets are protected from their financial liabilities.
  • Upon the death of the Settlor, a Probate Court need not be involved in the process of transferring assets, unless some dispute arises.

Cons

  • As the Settlor relinquishes all control over the assets in the Irrevocable Trust, they cannot change their decision of making the transfer.  If they suddenly change their mind and want their assets back, it is too late.
  • The Settlor loses their right to the assets mentioned in the Irrevocable Trust the moment they sign the document.  In addition, they also are deprived of the income generated from the trust assets.
  • The Settlor cannot add or amend something written in the trust.
  • Irrevocable trusts can be expensive to set up, depending on the complexity of the agreement and the amount of assets contained in the trust.
  • Irrevocable trusts are subject to a gift tax when the assets are transferred into the trust.
  • By nature, Irrevocable Trusts are not subject to much flexibility; once the terms are set, then they must be followed.  This is different from Revocable Trusts, which can be modified by the Settlor later on.

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