When most people think about trusts, the type they’re thinking about is a Revocable Living Trust (RLT). There’s another option, however, that estate-planning attorneys may present you with: an irrevocable trust. As you can probably tell by the name, an irrevocable trust can’t be undone. It’s also a separate legal entity from any other type of trust you may have. For it to function properly, the trust maker typically can’t be a beneficiary of the irrevocable trust. This means that once a trust maker puts something into an irrevocable trust, it’s out of the trust maker’s control.
There are two primary reasons that someone might want to use an irrevocable trust: asset protection and estate-tax reduction.
As an example, the proceeds of life insurance are taxable, but an Irrevocable Life Insurance Trust (a specific type of irrevocable trust) can remove the proceeds of life insurance from estate tax liability.
Another example is having the proceeds from a well-designed RLT pass onto beneficiaries in the form of an irrevocable trust — when this is done, the assets of each beneficiary are protected for their respective lifetimes.
One major drawback to an irrevocable trust, however, is its lack of flexibility.
Imagine that many years after an irrevocable trust is made, life isn’t working out as expected. Perhaps a beneficiary has become disabled, and access to the trust is interfering with his or her potential government benefits. Or suppose the tax code has changed and the trust is now causing tax consequences for the beneficiaries that didn’t exist when the trust was made. Is there a way to modify the irrevocable trust? Until recently, the options to alter irrevocable trusts were few and, even if available, often prohibitively expensive.
New developments in estate-planning techniques, however, have opened up some options to provide flexibility and control to makers of irrevocable trusts and their beneficiaries.
One example of a tool used to modify irrevocable trusts is a “power of appointment.” Technically, a power of appointment is a personal right to dispose of property. But when applied to a trust, it can give a beneficiary or other trusted person the right to change the terms of an irrevocable trust if things aren’t working as expected.
Another way to make changes to an irrevocable trust is to appoint a trust protector. A trust protector is a person whose role and authority is defined in the trust document. They can be named in the trust document or can be called upon later by those with authority to do so (like a spouse, beneficiary, or trustee, depending upon the trust maker’s wishes). Once called upon to serve, the trust protector can use the authority granted by the trust document to make changes to the irrevocable trust so that it continues to perform in the way the trust maker intended.
Some jurisdictions have also passed laws allowing irrevocable trusts to be amended, often without court involvement, through a process called decanting. This process provides continued control over irrevocable trusts, which allows the beneficiaries to make changes as needed.
An irrevocable trust can be a useful tool, and the inflexibility problems associated with them can be overcome with proper planning. If you’re the beneficiary of an irrevocable trust, or think that an irrevocable trust might be useful in your own planning, make sure to consult an attorney who is well-versed in these techniques. After all, you wouldn’t want a document designed to help protect your legacy backfiring, instead making life more difficult for you and your beneficiaries.