An irrevocable trust is one where the Settlor (the person who established the trust) does NOT retain powers to revoke or amend the trust. This sounds pretty permanent, right? Even though the Settlor can’t revoke or amend the trust, if drafted properly, other mechanisms can be used to add broad flexibility to the trust.
Also, just as a quick review, a revocable trust is one where the Settlor DOES retain powers to amend or revoke the trust. This is the most common type of trust people create for estate planning. Note however that a revocable trust becomes irrevocable upon the death of the Settlor(s).
Why Would You Create an Irrevocable Trust?
There are many valid reasons including, 1) Asset Protection, 2) Estate/Inheritance Planning, 3) Estate and Gift Tax Planning, 4) Income Tax Planning, and 5) Charitable Planning, among others.
What are some commonly used Irrevocable Trusts?
Here’s a list of a few popular types and uses:
- Asset Protection:
- Domestic Asset Protection Trust (DAPT – Self-settled Spendthrift Trust)
- Foreign Asset Protection Trust (FAPT, Offshore Self-settled Spendthrift Trust)
- Third-party Trust (SPA Trust)
- Tax Planning:
- Intentionally Defective Grantor Trust (IDGT) – Estate Tax
- Irrevocable Life Insurance Trust (ILIT) – Estate Tax
- Grantor Retained Annuity Trusts (GRAT) – Estate Tax
- Incomplete Gift Non-Grantor Trust (e.g. NING, DING, WING, AKING) – Income Tax
- Complete Gift Non-Grantor Trust – Estate and Income Tax
- Charitable Trust (CRUT, CRAT, CLUT, CLAT) – Estate and Income Tax
- Revocable Trust Becoming Irrevocable: QTIP, Bypass, Disclaimer, or Beneficiary Trusts – These provide tax and asset protection planning and are commonly established when a revocable trust becomes irrevocable upon the Settlor’s death
Can an Irrevocable Trust be Modified?
Absolutely! There are two main ways to modify an irrevocable trust.
- Careful Drafting. Include provisions in the trust document which give flexibility. For example, you could nominate a Trust Protector with the authority to make certain trust modifications. You can also grant powers of appointment to someone (sometimes even the Settlor).
- State Laws. If the trust document doesn’t include provisions allowing for modification, state laws may be the last resort. State laws allow modifications to irrevocable trusts, sometimes with and sometimes without judicial approval. This varies by State.
We often hear people make incorrect assumptions about irrevocable trusts, even attorneys, CPAs, and financial advisors. Here are some examples:
“an irrevocable trust can’t be changed”
“an irrevocable trust pays income tax in the highest tax bracket”
“an irrevocable trust requires the Settlor to file gift (or income) tax returns”
The term irrevocable doesn’t tell us anything about the trust’s tax treatment, asset protection, or flexibility. While the above statements may be true in some cases, they are not in others. Irrevocable trusts can be treated in many different ways for income, gift, and estate taxes, and can provide varying degrees of asset protection.
When you see irrevocable, you should ask questions rather than make assumptions. They can be treated in many different ways for tax purposes and can be extremely flexible. They are sophisticated documents. While they are sophisticated, they don’t need to be complicated. Make sure that a knowledgeable attorney prepares it for you. An attorney who knows how to incorporate flexibility and accomplish the intended purpose. Contact us to see how we can help make your planning simple for you.