Estate Planning Guide

What is an Irrevocable Trust? Should I Set One Up?

What is an Irrevocable Trust? Should I Set One Up?

If you’re asking what is an irrevocable trust, you’re probably first wondering how it would apply to your estate planning. The biggest benefit to an irrevocable asset is that once the assets have been transferred into it, it remains untouchable, keeping it protected against creditors and taxation. Learn more about how they work.

Stephanie Faris

Published March 15th, 2022

Table of Contents

Key Takeaways

  • An irrevocable trust means you can’t change or access the assets in it once you’ve finalized everything.
  • Irrevocable trusts can protect your assets from creditors and taxation while you’re still alive.
  • There are different types of irrevocable trusts, each with its own benefits.

As you near retirement, your planning naturally shifts. Yes, making sure you have enough set aside to pay expenses is important, but estate planning is also important. A will is a great first step, but an irrevocable trust can help you secure your assets, ensuring they go exactly where you want them to go.

If you’re asking what is an irrevocable trust, you’re probably first wondering how it would apply to your estate planning. The biggest benefit to an irrevocable asset is that once the assets have been transferred into it, it remains untouchable, keeping it protected against creditors and taxation.

What is an Irrevocable Trust?

An irrevocable trust can best be explained when you define irrevocable. If something is irrevocable, it cannot be changed or modified. It’s final.

With an irrevocable living trust, you move assets into a trust with the understanding that in doing so, you’ll no longer have ownership of those assets. You can’t modify or cancel the trust without the express permission of the beneficiaries. In fact, all beneficiaries will have to put their agreement in writing in many states, so an irrevocable trust is a big decision. Here’s what you need to know before setting one up.

Revocable vs Irrevocable

There are two major types of trusts: irrevocable and revocable. A revocable trust, also known as a living trust, can be altered or canceled at any time, which may seem like a big benefit on the surface. However, assets in a revocable trust aren’t protected from creditors or legal action, and after your death, they’re subject to federal and state income taxes.

That’s where the benefits of irrevocable trusts come in. The irrevocable trust definition states that you can’t change or cancel it without the permission of the beneficiaries. Laws on an irrevocable trust in California or Florida could differ from laws in Montana or Oregon, so it’s best to consult an attorney before deciding whether to go with an irrevocable or revocable trust.

How Does an Irrevocable Trust Work?

You don’t have to read an Irrevocable Trusts for Dummies book to understand how they work. There are essentially two parts to setting up a trust, whether it’s irrevocable or revocable. There’s the legal document, which states exactly what you’re transferring into the trust and the names of your intended beneficiaries. There’s also a bank account that is designated to hold any financial assets.

When you look at how to set up an irrevocable trust, there’s one big question. Will you pay an attorney to draft the legal document or use an online template? With an irrevocable trust, professional legal advice can be even more valuable, not just in helping you understand how does an irrevocable trust work but also in making sure that your assets will be properly protected.

Benefits of an Irrevocable Trust

Yes, an irrevocable trust can be quite a commitment. So why would you want an irrevocable trust? One reason is simply that it tucks your assets away where they can’t be touched. If you want to make that commitment and hold yourself to it, this could be the way to go. But it also sets some of your assets aside so that they don’t show up when you try to qualify for government programs like Medicaid or SSI. They also, of course, aren’t accessible to creditors.

There’s another reason that an irrevocable trust might be right for you, though. Knowing that the answer to “Can you transfer assets out of an irrevocable trust?” is no, you can set up a grantor retained annuity trust that lets you pay yourself an annuity each year, which can be a good tax move in some cases.

Types of Irrevocable Trusts

That said, there are several types of irrevocable trusts to look into when you die. These include:

  • Asset Protection Trust (APT) – This gives you the protection of a non-revocable trust while still giving you access to it.
  • Irrevocable Life Insurance Trust (ILIT) – You can have one or more life insurance policies designed to transfer to the trust.
  • Intentionally Defective Grantor Trust (IDGT) – This trust transfers all tax liabilities to your own tax burden rather than passing them to your beneficiaries.
  • Charitable Remainder Trust (CRT) – If you want to include charities in your estate, this is a way to ensure the money passes there securely.
  • Qualified Personal Residence Trust (QPRT) – To transfer your home to your trust, you’ll need this type of trust.
  • Grantor Retained Annuity Trust (GRAT) – This is the above-mentioned type of trust where you pay yourself from the trust.

Tax Benefits & Irrevocable Trusts

There are two instances where you benefit from irrevocable trust taxes. The first is while you’re still alive. Often those looking into “What is an irrevocable living trust?” like the fact that some of their assets will be set aside, untaxed, until they die.

The second benefit that has people looking for irrevocable trust trustees happens after death. The IRS looks at trusts as independent entities and therefore the trust will be taxed rather than as part of your own income. This can put the trust in a lower tax bracket, thereby saving money on taxes after your death.

Final Thoughts

Now that you know what does irrevocable trust mean, it’s important to weigh the pros and cons and decide if it’s the best choice for you. Each person’s circumstances is unique, so it’s important to know all the facts before you decide. A certified financial planner can look at your own assets and beneficiaries and help you decide the best type of trust to ensure your assets have the most protection possible.

Estate Planning Guide

Intro to Estate Planning

Wills

Trusts

Divorce Considerations For Retirement

Estate Settlement

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Author

Stephanie Faris

Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a writer for a credit card processing service and has written about finance for numerous marketing firms and entrepreneurs. Her work has appeared on Money Under 30, The Motley Fool, MoneyGeek, E-commerce Insiders, and GoBankingRates.

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