Trusts come in many shapes and sizes depending on your goals. Some avoid probate. Others reduce or eliminate certain types of tax. And still others can shield assets from lawsuits. But what is right for you will depend on your circumstances.
Trusts generally fall into two categories: Revocable and irrevocable. Revocable trusts can be freely amended or ended. And, generally, you’ll retain significant control of the trust and its assets. Irrevocable trusts, by contrast, are difficult to change or terminate. Plus, you’ll largely give up control of the trust and its assets to a trustee.
At this point, you’re probably thinking that irrevocable trusts sound like a bad deal. After all, few people want to give up control of their money or property. And even less people want to lose the ability to amend their trust as circumstances change.
So, why would anyone want an irrevocable trust? Because irrevocable trusts offer four advantages that revocable trusts cannot.
The first advantage is asset protection. In other words, if you lose a lawsuit, assets held by a revocable trust will be at risk. But if those same assets were in an irrevocable trust, then they would normally be safe. This kind of trust is frequently known as an asset protection trust. These trusts, in turn, are typically located in jurisdictions with favorable laws like Nevada and South Dakota—and, hopefully soon, the CNMI.
But is asset protection worth the cost of setting up and maintaining an irrevocable trust? It depends. For most people, probably not. But if you are an architect or surgeon, you may want to set up an asset protection trust because the likelihood that you’ll lose a big-dollar lawsuit at some point is much higher than the average person.
The second reason people like irrevocable trusts is for tax planning. Revocable trusts generally offer no tax advantages. But irrevocable trusts provide options for reducing your taxes, especially estate tax, which maxes out at 40%. Popular trusts for doing so include irrevocable life insurance trusts, grantor retained annuity trusts, charitable remainder trusts, and charitable lead trusts.
But just like asset protection, tax planning is more important for some people than others. Currently, the estate tax only applies to individuals worth over $11.7 million. So, few people need to worry about it. But, at the same time, this number changes frequently and is much more likely to plummet than go up.
The third reason to choose an irrevocable trust over a revocable one is to maximize government benefits. To qualify for Medicaid or Supplemental Security Income, for instance, you cannot own or receive too much money. Otherwise, you won’t qualify for the program. Or, if you are already part of the program, you’ll lose future benefits.
Consider an example. Let’s say you are on Medicaid and then your father passed away. As a result, you inherited a little money. That inheritance could knock you out of the program even if the inheritance is relatively small because the income and asset limits for government benefits is low.
A common way to address this situation is through a Medicaid trust. The idea is to transfer many of your assets into an irrevocable trust long before you apply for government benefits, and then have an independent trustee control the trust and its assets. That way you don’t own or control the assets and, therefore, can truthfully omit that money and property when disclosing your income and assets to the government.
But while these kinds of trusts often work, there are no guarantees. The reality is that the rules surrounding this situation are constantly changing. And the trend is for jurisdictions to make it harder for people to use irrevocable trusts to bend income and asset limits.
A final reason people like irrevocable trusts is the control and protection they offer beyond the grave. That is, an irrevocable trust allows you to create instructions that the trustee must follow even though you are gone. Worried that your son won’t finish college? Write an instruction that if they don’t graduate, they will get a smaller chunk of the trust assets. Concerned that your kids are not ready to receive a chunk of money? Then instruct the trustee to distribute the money in smaller dollops at the ages of 25, 30, and 35. Nervous that your daughter will get divorced, thus leading to her ex getting half of the money that you planned to give your daughter? Then have the trustee send money in regular intervals rather than all at once. That way, if your daughter gets divorced, then any trust money distributed after the divorce will never make it to the ex.
There are many kinds of trust to choose from. The right one will depend on your situation. For many people a revocable living trust is all they’ll need. But if any of the advantages discussed here apply to you, then you may want to investigate setting up an irrevocable trust with an experienced estate-planning attorney.
This column is for informational purposes only and is not intended to be taken as legal advice. For your specific case, consult a lawyer.