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What is an Irrevocable Trust?

Irrevocable Trust Definition

An irrevocable trust is an agreement allowing property to be held by one party for the benefit of another, stipulating that that it cannot be readily revoked, altered, or amended. It is commonly used for asset protection and estate planning. A trust is a legal tool that consists of a Settlor who has the trust created, a Trustee who manages the trust and one or more Beneficiaries who receive the benefits of the trust. You will also hear a Settlor also referred to as a Grantor or Trustor.

binding irrevocable trust

Revocable vs. Irrevocable Trusts

A revocable trust, commonly a revocable living trust, is an estate planning tool that can be changed by the settlor at any time.

So, if  your needs change you can make amendments freely without the interaction of a third party. This document utilized to make the changes is commonly referred to as is called a trust amendment or restatement.

So, why doesn’t everybody use a trust that is revocable as opposed to an irrevocable one? It is because the living trust is considered part or your own estate for tax and asset protection purposes.  So, a revocable trust offers no protection from creditors or those who seek to sue you. It also offers no segregation of assets in order to qualify for Medicaid assistance. Plus, upon your death, such a trust would be considered yours for state and federal estate tax purposes.

Why Irrevocable?

The primary reason people use irrevocable trusts to protect assets from lawsuits. Legal theory commonly allows a creditor to step into the shoes of the debtor and do what he or she could do. For example, if the settlor of a trust could freely change the beneficiary, the one who sued the settlor can step into his or her shoes and change the beneficiary to himself. If the trust allowed the settlor to independently spend trust assets on himself, the creditor could do the same.

Plus, some people want to use irrevocable trusts to make sure their wishes are carried out. This is common in second marriages where a spouse wants to make sure that children from the first marriage get at least some of the assets.

This article will primarily focus on the use of an irrevocable trust to protect assets from lawsuits, judgments and creditors. It will also touch on its role as an estate planning tool.

You Mean, I Can’t Ever Change It?

It’s not quite like that, as there are often ways to make changes. It depends on how the trust is drafted. But if the purpose is asset protection, the changes often require the approval of a third party, such as the trustee. Most trusts for this purpose are discretionary trusts. For example, if you decide to cut out a beneficiary or add a new one, simply ask the trustee and the trustee, at his, her or it’s (in the case of a corporate trustee) discretion can do so. The trustee has discretion to decide whether or not the act would be in the best interest of the beneficiaries of the trust, complies with the settlor’s intent, the overall purpose of the trust, and if doing so would or would not put trust assets in harm’s way.

Trust Deed Amendment Sample
With most irrevocable trusts, the Settlor(s) or Beneficiary(ies) may request that the Trustee make certain changes. The trustee can generally do so if it does not put trust assets at risk.

 

To say it another way, if you could change it directly, the judge could force you to change the beneficiary to your legal enemies. So by making it irrevocable, you are more likely to get what you want: the use of the trust assets. By requiring a third party intervention, it ties the judge’s hands from directly forcing you to make the changes against your will.

Allowances for the Unforseen

Properly drafted trusts allow for wide range of future possibilities. For example, there are circumstances that would warrant a change of beneficiaries or trustees. Perhaps Mom and Dad unexpectedly have another child. One child exhibits evidence of long-term substance abuse. On child has a tragic military accident while the parents are still living. The trustee dies. All of these circumstances and more are accounted for in a well-drafted trust.

How Can It Be Irrevocable If I Really Can Change It?

Notice the operative word, “I.” Irrevocable doesn’t necessarily mean nobody on the planet can change it. It doesn’t mean that you cannot suggest a change to someone else. It just means that certain people cannot, independently, without outside cooperation, change it. This is a good thing. Remember, if you could just change the beneficiary at a whim, the judge could force your whim to be your enemy at law.

We all like control, but if the trust is written improperly and you have complete power to change the trust and then you get creamed in the courtroom, the only one who would have the control at that point would be the judge. And that would likely not be a good thing for you. That’s because he’ll force you to use that control and change the beneficiary to the person who sued you and allow them to take all of the money held therein that is needed to satisfy their judgment.

So, to have real control, set up an irrevocable trust, with an independent trustee. Then you put yourself in control instead of the guy who is suing you.

Why Choose an Irrevocable Trust Over Other Trusts?

A trust can be used to protect assets, but every trust is not equal to the next trust agreement, not by a long shot. A properly drafted irrevocable trust can protect assets from creditors, unnamed family members seeking to be added as beneficiaries at the grantor’s death, or anyone else trying to take the grantor’s assets. Creditors have to show a court a fraudulent conveyance occurred within specified timeframes before an irrevocable trust can be tapped by a creditor.

Domestic Irrevocable Trust For Asset Protection

As stated, whatever the settlor (the one who created and funded the trust) could do, the judgment creditor can step into his shoes and do, too. Can the settlor freely change the beneficiary to himself and spend all of the money? If so, the judge could order the settlor to change the new beneficiary to the one who just won a lawsuit against him. Then, the settlor’s legal enemy could take the money out of the trust for his own benefit. So, since the irrevocable trust limits the settlor’s ability to change the beneficiary, one’s legal enemy is prevented from doing the same. Thus, it is the type of trust utilized for asset protection. Such a trust based in the US is called a Domestic Asset Protection Trust (DAPT).

As of this writing there are several states that offer irrevocable trusts for asset protection. They include Nevada, South Dakota, Tennessee, Ohio, Delaware, Missouri, Alaska, Wyoming, Rhode Island, New Hampshire, Hawaii, Utah, Mississippi, Oklahoma, Virginia and West Virginia. Their case law is fairly favorable for those who live in those jurisdictions. However, even for residents, we have seen these types of trusts penetrated for asset protection purposes because the trustees reside within the jurisdiction of the US courts. Case law tends to favor offshore asset protection trusts.

Offshore Irrevocable Trust For Asset Protection

Offshore irrevocable trusts, step it up a notch. With a trust in the Cook Islands (south of Hawaii) or Nevis (in the Caribbean Sea), you can be the settlor and the beneficiary. These jurisdictions have special laws so that you can still maintain some control, in cooperation with the licensed, bonded trustee, and still keep your assets away from creditors. It is referred to as an Offshore Asset Protection Trust (OAPT).

The biggest benefit is as follows. Since the trustee resides abroad, the local court does not have jurisdiction over the trustee. So, the trustee need not comply with foreign court orders.

Trusting the Trustee

Trustees in these offshore asset protection trust jurisdictions go through intensive background checks to obtain their licenses. They are bonded by insurance companies to act in the beneficiary’s best interest. Since a major part of the revenue to these jurisdictions are from trustee services, there is a major incentive to keep their reputations in the best of standings.

They Work

Why use an offshore irrevocable asset protection trust? Quite simple They work. This company has been in the industry since 1994.We have also seen these trusts protect assets in every instance in which they have been challenged. Moreover, we have never seen a trustee in either of the two regions mentioned above perform an act that would improperly cost the settlor or beneficiary a loss of trust funds.

drawing of boy and man

Irrevocable Trust for Estate Planning

Here is a typical scenario when using an irrevocable trust for estate planning purposes. Bill and Mary set up an irrevocable trust. They make their children the beneficiaries. When they die, the children receive payments from the trust. The children may be able to receive a set monthly amount for a lifetime. They may be able to receive enough to pay for a college education.

The trust may be drafted so that they are able to receive the money all at once (not usually a wise thing for a youngster) or so that they may receive enough for maintenance, support and education. Afterwards they may get a set amount at, say 25, more at 30 and the remaining balance at 35, for example. Bill and Mary may be able to borrow money out of the trust for their own use, so there are ways that they can still have access to the funds during their lifetimes. With an offshore trust in the proper region, Bill and Mary can be the beneficiaries during their lifetimes. Children typically become beneficiaries after the death of both parents.

Irrevocable Trust: What to Know

When you have an irrevocable trust created, you must be very sure about what you are doing. There are restrictions on making changes later. However, with most irrevocable trusts, there are often ways that you can modify or terminate them, to a certain extent, with the permission of the beneficiaries and/or the trustee.

If you’re considering estate planning – whether to care for a loved one after your death, to make sure your personal items are distributed to the right people upon death or to alleviate taxes for survivors – there are many tools that can help you accomplish your goals. Wills and trusts are commonly used, but trusts have the significant advantage of avoiding expensive probate fees and specifying who gets what and when they will receive it. For more detailed information there is an article entitled Irrevocable Trust Miscellaneous Provisions that discusses the requirements at a greater depth.

What Does an Irrevocable Trust Do?

For starters, irrevocable trusts can be great tools for estate planning and reducing death tax liability. That’s because an irrevocable trust removes assets from a person’s estate – while the person is still alive. Why would anyone want to do that? Because by doing so, it will remove the assets from being able to be taken in a lawsuit against the one who had the trust established (the grantor or settlor). This means that the grantor – the person creating the trust – or the beneficiary of the trust won’t have to worry about the seizure of trust assets. Plus, the tax implications of an asset upon the grantor’s death are removed. So, irrevocable trusts protect assets, eliminate probate fees and reduce estate taxes, which is why people use them.

How Does an Irrevocable Trust Work?

An irrevocable trust involves three individuals: the grantor, a trustee and a beneficiary. The grantor creates the trust and places assets into it. Upon the grantor’s death, the trustee is in charge of administering the trust. This means that he or she is responsible for distributing the assets in the trust according to the grantor’s wishes. The trustee has an important job, as he or she must protect the assets. The beneficiary is the person who receives benefit of the assets.

Assets placed into the trusts are considered gifts and cannot be removed at a later date. The grantor, however, does have the ability to create the exact terms and rules that must be followed, as long as he or she has the consent of both the trustee and beneficiary. For example, the grantor may ask that the money placed in an irrevocable trust be used for a specific purpose, such as for college or a wedding.

signing agreement

Applications of Irrevocable Trusts

Irrevocable trusts have many uses for those looking for a good asset protection and estate planning tool. Some benefits include the following:

  • Protecting assets from judgements and creditors.
  • Removing taxable assets from the estate so that the grantor can take of advantage of estate tax exemptions.
  • Removing appreciating assets from the estate and allowing them to take on a better value so that beneficiaries don’t have to pay so much in taxes
  • Gifting a home to children with less tax implications
  • Gifting assets while being able to retain the income they generate
  • Preventing misuse by greedy beneficiaries, since the assets can be held in the trust and distributed per the grantor’s wishes

Types of Irrevocable Trusts

There are many types of irrevocable trusts that can help you secure your assets and reduce taxes. They include the following:

  • Asset Protection Trust

    An asset protection trust is used to prevent assets from being taken by creditors. There are asset protection trust laws in states such as Nevada, Wyoming, Delaware, Alaska and North Dakota. In practice, we have found that they can provide a fair level of protection, especially, for residents of those states. However, they have the disadvantage of being under US court jurisdiction. Judge’s do not always follow the law and there are ever-expanding legal theories of liability. So, we have seen assets in domestic trusts seized on numerous occasions. Offshore trusts in jurisdictions such as the Cook Islands and Nevis have a perfect or near-perfect track record for protecting assets from judgment creditors. Because US judges do not have jurisdiction over foreign trustees, the trustee need not comply with US court orders.

  • Bypass Trust

    This type of trust is used by those who are married. When one spouse dies, the property goes into the trust. The surviving spouse can use the property, but does not own it. This means that when the surviving spouse dies, it is not included in the estate, which equates to tax savings.

  • QTIP Trust

    Another trust designed for married couples, a QTIP trust typically provides income to the surviving spouse when one spouse dies. When the second spouse dies, the assets are then given to other named beneficiaries, typically the settlor’s children. QTIP stands for Qualified Terminable Interest Property.

  • QDOT Trust

    A QDOT trust is similar to a QTIP trust, except that it is used when one spouse is a noncitizen. QDOT stands for Qualified Domestic Trust.

  • Life Insurance Trust

    With this type of trust, the trust is both the owner and the beneficiary of the life insurance policy. Anyone, in turn, can be the beneficiary of the trust. The trust must typically be created at least three years before the grantor’s death. It lets a person reduce or eliminate estate taxes so more of the proceeds go to the beneficiaries. The trustee, then, administers insurance proceeds for one or more beneficiaries.

  • Generation-Skipping Trust

    This tool is often used for wealthy families. As the name implies, the trust skips a generation. The final beneficiaries are the grandchildren instead of the children. The children are beneficiaries of the income, but do not own the property. This means that when the children die, their trust property is not subject to estate tax. However, a generation skipping transfer tax may apply.

  • Charitable Trust 

    If you don’t have any family – or maybe you do have family but don’t want to give them an inheritance – you can opt for a charitable trust. This may be a good choice if you are not married and have no children. This type of trust allows you to give gifts to charity as a way to lower income and estate taxes. The charity benefits from your donation as well, so it’s advantageous to both parties. There are three types of charitable trusts.

Types of Charitable Trusts

  1. Pooled income trust: This trust allows you to pool your money with other grantors and receive income for a specified amount of time. For these trusts, the charity is the trustee and beneficiary.
  2. Charitable lead trust: Property is put in a trust. You name a charity to receive income from the trust for a certain amount of time. Someone else, however, is named as the final beneficiary.
  3. Charitable remainder trust: Property is put in a trust. You can receive a tax deduction for putting the money into the trust. You name someone to receive income from the trust for a certain amount of time. The charity is named as the final beneficiary.

Trusts for Special Needs

If your goal is to protect assets and income for loved ones, choose one of these trusts:

  • Special Needs Trust 

    If you have a child or other loved one with special needs, a special needs trust can help provide financial support for this person in the event of your death. Property – particularly money – is placed in the trust. A trustee is appointed to distribute the funds to buy necessities for the disabled person. The beneficiary never owns the property, which works to his or her advantage because the money is not considered as asset. The beneficiary does not make too much income and therefore can still qualify for government benefits.

  • Spendthrift Trust 

    Maybe you don’t have a disabled relative, but maybe you have a sibling or child who is horrible with money. Some people are just irresponsible with money, but that doesn’t mean that you need to leave them out of your inheritance. With a spendthrift trust, you can protect and control the money that you gift to family members who have trouble managing their finances. The assets are put in a trust and a trustee doles them out based on the terms in the trust. For example, you may allow the beneficiary to receive only a certain amount per week or month. The beneficiary cannot access the trust property, so the assets are protected from creditors. However, once the beneficiary receives money or assets, they become fair game.

family picnic

Is an Irrevocable Trust the Way to Go?

Irrevocable trusts offer many asset protection, estate planning and tax advantages. For the general public, an irrevocable trust may be very useful in protecting assets from lawsuits, securing financial help for a special needs child or providing for children after the death of the parents.

You need to be able to trust your trustee. What happens if you have a falling out with your trustee? Change them. The beneficiaries can simply vote in a new trustee. The trustee must not be you. The trustee also must not be someone up or down the family tree, cannot be a controlled employee and cannot be an agent of yours. If any of these parties were trustees it would lose its asset protection advantages because the courts would consider these people your alter ego.

Should you choose an irrevocable trust, some wise advice is to have it skillfully drafted by an experienced professional. This is extremely important, since a poorly worded document may not do what you intended for it to do and ruin your asset protection and estate planning goals. Contact an estate planning expert to see if an irrevocable trust will meet your needs based on your unique situation.


Linsay Thomas, Technical Editor, contributing author