What is an Irrevocable Trust?

An irrevocable trust is a separate legal entity, with its own tax identification number, set up by the trust creator (Settlor) to hold assets. Once assets are transferred to an Irrevocable trust, they cannot be taken back, and the terms of the Irrevocable trust generally cannot be changed after the document is signed.

Assets that are transferred to the trust are considered ‘gifts’ to the trust. That means that a Gift Tax Return (IRS Form 709) may be required to report the gift to the IRS. The biggest advantage to an Irrevocable Trust is that they provide a way to remove assets from a person’s taxable estate, yet the person can designate where those funds will go upon his or her death or the occurrence of some other event. Most people who consider Irrevocable Trusts are in a situation where substantial estate taxes would be due upon death if assets were not removed from the estate.

A few of the more common types of Irrevocable Trusts are summarized below.

Irrevocable Life Insurance Trusts (ILIT). An ILIT is an easy and efficient way to remove assets from the taxable estate while having little or no gift tax consequences. Also, a great way to get a substantial tax-free distribution to children upon death. People often use these in conjunction with a charitable giving strategy. That way, they feel they are not ‘short-changing’ the children by giving a generous gift to charity.

  • Trust is created, trustee purchases a life insurance policy on the trust creator’s (Settlor) life.
  • Settlor usually makes annual gift ($15,000/$30,000 if married per trust beneficiary) to the trust to fund premium payments, but other methods of premium payment are also used
  • Beneficiaries must be notified when contribution is made of right to withdraw funds (“Crummey” notice)
  • Eventually policy will be ‘paid up’ and trust just waits for payout at death
  • At death, Life insurance proceeds pass to beneficiaries free of estate and income tax

Grantor Retained Annuity Trust (GRAT). These are used when significant assets need to be removed from a taxable estate, and there is a desire to minimize the gift tax impact.

  • Assets are transferred to an irrevocable trust
  • Grantor (Settlor) retains income payments for a period of years – this reduces the value of the gift
  • If grantor ‘outlives’ term, assets pass to beneficiaries or remain in trust for a period of years or until Grantor’s death
  • If grantor dies during the time he or she is still receiving the income payments, the transferred assets remain as part of the grantor’s estate. So it’s important that the Grantor be likely to live longer than the ‘retained interest’ period, or the strategy is ineffective.
  • Transferring the assets will minimize estate tax, but beware of capital gains!
  • Transferred assets take the same basis the grantor had, so upon sale, there may be significant capital gains.

Charitable Remainder Trust (CRT). A CRT is a great strategy for those who want to remove assets from their estate, provide for charity, and retain an income stream for lifetime.

  • Assets are transferred to an Irrevocable Trust. People often transfer low-basis assets to these trusts, due to capital gain treatment if the asset is sold within the charitable trust.
  • Tax deduction is taken in year of funding (or spread over 5 years) for present value of ‘gift’ amount
  • Income is paid to donor for a term of years or for life or over joint life
  • At grantor’s death, the balance goes to charity
  • May be used in conjunction with an ILIT; the income stream from the Charitable Remainder Trust could even pay the life insurance premiums, and the children get a wonderful tax-free gift upon death

Consult with your Estate Planning attorney for more complete information on these and other strategies. This information is not intended to be complete, so do not make decisions based on this article without having your attorney evaluate your specific situation.

Contact us today if you have questions about this topic or if we can assist you with your Estate Planning needs.

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