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Pros and cons of creating an irrevocable trust

On Behalf of | Jan 14, 2021 | Trusts |

Trusts are separate legal entities designed to manage a person’s assets. For those of varying degrees of wealth, they can be vital instruments for avoiding probate upon their death and reducing tax burdens.

Revocable, or living trusts, give the owner flexibility to change the terms at any time over beneficiaries and modifying stipulations on how the trust is managed. Irrevocable trusts, on the other hand, are basically set in stone the minute they are signed.

Benefits of an irrevocable trust

Once you create an irrevocable trust, you no longer control the assets it contains. It must be managed by an independent trustee and can only be modified, amended or terminated with your beneficiaries’ permission. Given its strict nature, there are three situations where it may be beneficial:

  • Reducing estate taxes: All assets placed in the trust are no longer taxable as they – and any income generated from them – are, in effect, owned by the trust and not the creator. These funds can be used to purchase life insurance or annuities as income streams or to set up charitable contributions after family members are compensated.
  • Eligibility for government programs: Rigorous income and asset limitations exist for disabled beneficiaries receiving Medicaid and Supplemental Security Income. Irrevocable trusts shield income and assets to avoid exceeding these limits.
  • Asset protection: Doctors, attorneys, real estate developers and others who are especially vulnerable to lawsuits can create “asset protection trusts” to safeguard property from creditors. These are usually created in states with favorable trust laws.

And the cons?

There is typically little need to create an irrevocable trust for tax reasons if your wealth is less than the current federal estate tax exemption threshold of $11.58 million per spouse. However, more sizable estates can benefit. It also makes little sense to create this type of trust for people who have no need or do not plan to qualify for Medicaid or other government programs.

Additionally, courts may also reclaim assets from these trusts if they believe the creator transferred them in anticipation of a lawsuit. Some states require that assets must be owned by the trust for a year or two before they are protected. Finally, the biggest negative for many is losing control of how these assets are managed.

Irrevocable trusts contain complex specific rules, which, if not followed at any time, can negate the advantages of creating them in the first place. That is why it is advisable to work with an experienced trust attorney who understands Connecticut laws and can advise whether an irrevocable trust is a good fit for your situation.