What is an irrevocable trust? When should I use one?
An irrevocable trust is a trust that generally cannot be changed or amended after its creation (unlike a revocable trust, which can be changed by you at any time - so long as you are of sound mind).
Irrevocable trusts should only be used for specific client situations - meaning not everyone needs or should have an irrevocable trust (although the industry has a tendency to highlight these trusts, which I think is primarily caused by the fact that they can charge more for them).
I personally do not like using irrevocable trusts unless the client is absolutely certain on what they are trying to accomplish and the trust matches the fact pattern presented - we do not want to try and shove a square peg into a round hole here.
So when does it make sense to use an irrevocable trust? Here are the three most common scenarios (that I see) when an irrevocable trust may make sense to a client.
NURSING HOME PROTECTION
We’ve all heard the horror stories of someone going into a nursing home and depleting all their assets in the process until there is nothing left to leave to the kids after they’re gone.
So a lot of clients understandably ask what they can do to protect against this scenario and the common response is to do an irrevocable trust.
However, this type of irrevocable is extra strict because the reality is that these are controversial trusts and if the grantor (the trust maker / creator of the trust) can access the principal under any circumstances, then the trust simply doesn’t work for its intended purposes.
That means when you are doing an irrevocable trust for nursing home care purposes (sometimes referred to as a Medicaid trust), you need to be aware that you are essentially giving up control of whatever asset you place in that trust - you and your spouse cannot be the trustee - and you can no longer access the principal or the equity in the asset transferred to the trust for the rest of your life.
Plus, you need to get beyond the 5 year look back period, meaning 5 years needs to pass after the asset transfer, in order for it to be a non-countable asset for Medicaid eligibility purposes.
2. SPECIAL NEEDS TRUSTS
If you are doing special needs planning for a beneficiary that is currently receiving or expects to receive government benefits in the future, then you may want to look into special needs trusts (often also referred to as supplemental needs trusts). Special needs trusts ensure the beneficiary remains eligible for such government benefits.
Traditionally, these trusts were created as irrevocable trusts (and first-party special needs trusts are still drafted as irrevocable), but if you are doing a third-party special needs trusts - in other words, if a parent or grandparent or aunt/uncle is creating a special needs trust for another person (e.g., a disabled child) then they wouldn’t necessarily need to make the trust irrevocable upon creation unless they intended others to fund the trust.
Let me use an example to clarify.
Susan has a disabled child, Daniel. Daniel is currently receiving government benefits. Susan creates an irrevocable trust for Daniel that would be funded with her assets upon her death, but can also be contributed to by other family members. Susan has a brother, Bob. Bob has no children and would like to leave money to Daniel, but knows he can’t leave it directly to Daniel because of the implications of doing so. Bob drafts his estate plan to make sure that the money left to Daniel doesn’t go to him outright, but instead passes to the irrevocable special needs trust established by his sister, Susan. Now Bob has peace of mind in knowing that the money he leaves to the special needs trust will help Daniel without causing problems down the road.
3. IRREVOCABLE LIFE INSURANCE TRUSTS
There are a smorgasbord of irrevocable trusts that are set up and funded to reduce or alleviate estate taxes, but one of the most commonly used tax protection trusts is an irrevocable life insurance trust (often referred to as an ILIT).
These trusts have the benefit of both removing an asset from your estate and providing liquidity to the family upon your passing (especially important if you have large illiquid assets or assets that your family doesn’t want to sell upon your death).
The basic idea is that you would have a life insurance policy (usually a term life insurance policy) owned by the ILIT. If done properly, that life insurance policy and the death benefit proceeds that come from it would not be considered part of your estate upon your death. For clients in Massachusetts, that could mean savings on up to 16% of the life insurance proceeds (160,000 on a million dollar policy) from estate taxes. If you are in the federal estate tax range, that could save you 40% (400,000 on a million dollar policy) from estate taxes.
For that reason, ILITs, and other irrevocable trusts are a common part of wealthy clients' estate plans - especially when they enter the federal estate tax threshold in terms of net worth.
If you have questions or concerns about irrevocable trust, or if you’d like me to review or create a trust for you, then click the link below to schedule a call with me today.
I’m always happy to help!
