The 3 reasons to establish an irrevocable trust

What is an irrevocable trust?

An irrevocable trust is the opposite of a revocable trust, meaning that you cannot change the terms of the trust once it is established. When you transfer assets to the irrevocable trust, you give up control of the assets and effectively transfer ownership away from yourself.

A transfer of assets to an irrevocable trust is usually considered a gift, meaning you are using up part of your gift-tax/estate-tax exemption, which is currently almost $14m per person.

Why have an irrevocable trust

There are only 3 major reasons why anyone would establish an irrevocable trust:

1. To minimize the burden of estate taxes: If your estate has the potential to be worth more than the estate tax exemption upon your death, then you might want to consider an irrevocable trust for some of your assets. This has the benefit of reducing your estate size to be under the estate tax exemption, thus minimizing taxes.

2. To protect assets from lawsuits and creditors: Correctly designed irrevocable trusts are inaccessible if you get sued. This can protect your wealth from frivolous lawsuits and ensure that your family inherits. Typically, people who work in litigious industries establish irrevocable trusts to protect their assets. These types of trusts are often called Asset Protection Trusts. While they are irrevocable, they sometimes allow slightly more control by the grantor (you) than an irrevocable trust whose purpose is estate tax minimization.

3. To qualify for certain government benefits: Some government benefits, such as Medicaid and programs for those with disabilities, have maximum asset levels before benefits cease. In order to continue to qualify, some people establish irrevocable trusts to keep their personal wealth below the asset threshold, while allowing their wealth in trust to continue to grow and provide for other needs.

Can I still use my money?

An irrevocable trust often means giving up control of your assets. However, just because you have given up control does not mean you cannot benefit. For the purposes of minimizing estate taxes, one common structure is the Spousal Lifetime Access Trust (SLAT).

In a SLAT, each spouse establishes an irrevocable trust for the benefit of the other. That way, the assets can continue to maintain each other in comfort for the rest of their days.

There are some catches to SLATs: First, you still must give up control to an outside trustee. This means the trustee will be responsible for determining what disbursements you need from the trust. Second, the two trusts cannot be perfect mirror-images of each other. Otherwise, the IRS will essentially say they cancel each other out and the assets are still in your estate. An experienced trust & estate lawyer can help ensure the both SLATs are similar but substantially different enough.

For asset protection trusts, the jurisdiction matters. At Toups Capital Advisors, we often advise clients to look at Nevada-based trusts. Nevada has very favorable laws protecting trust assets from lawsuits and creditors, while still permitting the grantor (you) some involvement with the trust. Nevada allows one trustee to serve as the Investment Manager and another to serve as the Administrative & Distribution Trustee. As long as you are not responsible for distribution of trust assets, your assets are protected and you can still manage the investments of the trust.

Contributing now versus later?

In general, it is better to establish and contribute to an irrevocable trust sooner rather than later. Let’s consider the timelines for each of the 3 reasons to establish a trust:

1. Estate Tax Minimization: If your goal is to minimize the burden of estate taxes, it is important to contribute to an irrevocable trust long before you expect to pass. That way, your assets can continue to grow without fear of incurring a large estate tax. If you were to wait until the last possible moment, it’s possible that your estate would exceed the value of the estate tax exemption. Furthermore, you wouldn’t be utilizing the benefit of the stepped-up cost basis on death.

2. Asset Protection: Jurisdictions vary, but all of them include some “cooling-off” period between when you place assets into a trust and when they are fully protected from a creditor. This is to prevent people from simply rushing assets into a trust after getting sued. This waiting period can be as short as 18 or 24 months, but it is still important to contribute assets before you anticipate a need for protection.

3. Qualifying for Government Benefits: Government programs often include a look-back to determine if you moved assets out of your estate for the purposes of qualifying. It’s important to transfer assets to a trust long before you anticipate needing the government benefits or before your assets grow too large.

Put it into practice

If you think an Irrevocable Trust might be a valuable part of your financial planning, contact us!

At Toups Capital Advisors, we are fee-only fiduciaries. We don’t collect commissions on the financial products we recommend, unlike many advisors and large banks. We always put your financial well-being first. Initial consultations are always free.