Should You Make an Irrevocable Trust?
When you want to set up a trust, there are a lot of decisions to make. A major one is whether the trust will be revocable, which means you retain power over it, or whether it will be irrevocable and you lose power to change or revoke it in the future. Many attorneys recommend using revocable trusts so that if your situation changes, you are not stuck in a difficult or unwanted position. However, there are times when an irrevocable trust may be appropriate.
The Benefits of an Irrevocable Trust
There are some clear reasons why you may prefer an irrevocable trust over a revocable one. Irrevocable trusts are more likely to provide tax benefits and protection from creditors after your death. By giving over the ownership of property to the trust, the assets no longer belong to you when you pass away. That means these assets will not be subject to estate taxes. If you want to transfer a significant value of money and property, this can be extremely helpful for your beneficiaries. It can also benefit your taxes for the rest of your life. With income-earning property moved to a trust, you could lower your own income tax liability.
Assets in an irrevocable trust are also unlikely to be subject to your creditor’s claims. This means they cannot be sold to pay off your debt. You may want this benefit if you are worried about your debts toward the end of your life. However, if you create an irrevocable trust after you are in legal or financial trouble, it could be considered fraudulent.
These assets can also be protected from the beneficiary’s creditors, if you set it up as a spendthrift trust. This type of trust enables the beneficiary to use the income and capital, yet limit the beneficiary from transferring or inappropriately managing the trusts and protect the property from their creditors.
Another benefit of an irrevocable trust is that it can ensure someone who needs financial help has it no matter what. This is often used if you have a disabled or dependent adult who will need financial stability once you are older or gone.
The Disadvantages of an Irrevocable Trust
The most important thing to understand about an irrevocable trust is that you cannot take it back easily. Irrevocable trusts are for individuals who are very confident in their decisions and financial futures. Once you set up an irrevocable trust, you do not have the right to quickly modify it in any way or disband it. If you insist on trying to change it, you will either need the written approval of all beneficiaries or court approval.
It may not create the perfect tax situation either. The trust will be taxed as a separate entity and subject to income tax. You should think of an irrevocable trust as a tool to avoid paying taxes entirely. The trustee will have to distribute a copy of a Schedule K-1 to every beneficiary and file a Form 1041 each year.
You may also have to pay a gift tax on property worth more than $13,000 per beneficiary each year that you move to the trust. You should speak with a tax professional about this potential liability before you create the trust.