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Irrevocable Trusts: What You Need to Know

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Your 2017 Guide to Trusts

Many people want to provide for their loved ones but in a way that allows them to retain control over their assets. An irrevocable trust can be a great way to achieve these estate planning goals. Irrevocable trusts have advantages over alternatives like wills or revocable trusts, but they also require a different way of thinking about your assets. With the potential for substantial tax savings and other benefits, irrevocable trusts are worth considering in your personal estate planning.

What's an irrevocable trust, and how does it work?

An irrevocable trust is a trust that you create to hold property for the benefit of someone else. What makes the trust irrevocable is that once you create it, its terms are set, and you can't make future changes to the trust document. That's in contrast to revocable trusts, in which the person who created the trust can typically change its terms or terminate the trust at will.

You can set up irrevocable trusts in several different ways. The simplest is to make an irrevocable trust during your lifetime. This involves preparing the trust document, transferring property to the trust, and then signing the trust agreement to make the trust effective. From that point on, the trustee is required to follow the terms of the trust, which will govern things like how the assets will be invested and who is entitled to receive distributions from the trust either now or in the future.

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You can also leave provisions for irrevocable trusts in other estate planning documents that won't take effect until your death. Irrevocable trusts are commonly found in wills, and these testamentary irrevocable trusts don't come into existence until the death of the person creating the trust. During your lifetime, you can still make changes to your will, and you can therefore modify the terms of the irrevocable trust. After your death, the executor or personal representative overseeing your estate will follow the instructions left in the will to create the trust, and then whoever is named as initial trustee will take control of the trust and follow those instructions going forward. Similarly, if you have a revocable trust, it will often become irrevocable at your death if you leave instructions for property to remain in trust beyond your lifetime.

The biggest estate-tax benefit of irrevocable trusts is that you can structure them so that once you make an initial gift to the trust, any future appreciation in the property it holds won't be included in your taxable estate, leading to extensive tax savings. If you invest $10,000 in a regular account and it grows to $1 million in 30 years, then the full $1 million will potentially be subject to estate tax. If you instead put $10,000 in trust and then invest it, the resulting $1 million won't be included in your estate. Rather, you'll potentially use up $10,000 of your lifetime gift tax exclusion when you make the initial trust contribution, but future appreciation will belong solely to the trust beneficiaries.

What special types of irrevocable trusts are there?

There are several types of specialized irrevocable trusts that are commonly used in estate planning. The irrevocable life insurance trust is designed to hold life insurance policies. By having the policy owned by a trust rather than in your own name, you'll avoid having the death benefit included in your estate. For high-value policies for wealthy individuals, that can produce hundreds of thousands or even millions of dollars of estate tax savings.

Another common irrevocable trust is the charitable trust. With these trusts, the person creating the trust will often retain certain rights, such as income payments for life. At the person's death, charitable remainder trusts pay any trust assets that are left to charity, terminating the trust. By creating charitable trusts, you can often get an income tax deduction for the charitable gift while guaranteeing an income stream for yourself.

Dynasty trusts are a relatively recent creation. Designed to last for multiple generations, dynasty trusts have the goal of paying as little estate tax as possible while making wealth available to families for decades or even centuries into the future.

Finally, some irrevocable trusts are designed to maximize control of assets. You can create a spendthrift trust to hold property for a loved one who isn't financially responsible, ensuring that money will be available when needed. Special needs trusts are designed to help those who are eligible for government assistance, providing supplemental financial support without making the beneficiary ineligible to receive badly needed benefits from state or federal government programs.

Irrevocable trusts can seem scary, because once you pull the trigger on them, you can't change your mind. However, by planning careful and prudently, you can reap big benefits from using irrevocable trusts in your estate planning.

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