How an irrevocable trust can be a vital tool in your financial strategy

You want your loved ones to be taken care of after you pass away, and a trust could be an important part of the legacy you leave behind. A third party, or trustee, manages the assets you place within a trust for the benefit of one or more beneficiaries. Depending on how the trust is structured, certain conditions must be met for the beneficiaries to receive the assets.

A trust can be irrevocable or revocable. So, what is an irrevocable trust, and how does it differ from a revocable trust? And what types of irrevocable trusts are available? Here's what you should know.

In short, an irrevocable trust is a trust that holds deposit accounts established through a statute or other written agreement. Once formed, an irrevocable trust can't be changed without a court order or by mutual agreement of the trust's beneficiaries. This applies to any modification, amendment or cancellation. Within the structure of this type of trust, there are key roles that contribute to how it works. These include:

• Grantor. This is the person(s) who forms the trust by giving the assets to be set aside. The grantor decides how the trust is structured and chooses one or more beneficiaries.
• Trustee. The trustee is responsible for making sure the trust is administered according to the legally binding terms of the agreement. Trustees have a fiduciary responsibility to manage the assets in the beneficiaries' best interest.
• Beneficiary. A beneficiary is the person or entity that receives the benefits of the assets held in the trust. There must be at least one beneficiary, but there can be multiple.

Choosing whether to establish a revocable or irrevocable trust depends on your needs and goals in forming the trust. The key difference between these trusts is that while you generally can't modify or terminate an irrevocable trust once it's formed, you do have that ability with a revocable trust.

If you can make changes as you see fit with a revocable trust but not with an irrevocable trust, why would you choose an irrevocable trust and give up that control? An irrevocable trust can provide several distinct benefits. Depending on your goals for the trust and reasons for creating it, these advantages may make an irrevocable trust a better choice.

Most benefits an irrevocable trust provides rely on the fact that assets in an irrevocable trust no longer belong to you as the grantor. They become the legal property of the trust. As such, here are some factors to consider when establishing your trust as irrevocable:

• The assets aren't included in your estate. This can help reduce the size of your estate and the amount of any tax liability the estate may incur.

• Any income the assets produce in the irrevocable trust is taxed to the irrevocable trust and isn't included in your taxable income. The trust is its own taxpayer.

• Placing assets in an irrevocable trust provides protection from creditors' claims and judgments from lawsuits because it removes them from your ownership.

• If structured correctly, these assets no longer count against you or the beneficiary when it comes to qualifying for government assistance related to disabilities or special needs, like Medicaid or Supplemental Security Income.

Many types of trusts can be made irrevocable. Some examples include:

A trust whose terms become effective during your life is a living trust. In contrast, a testamentary trust only becomes effective when you pass away. Living trusts can also be revocable.

Holding life insurance within a trust prevents the death benefit from being included in your estate. The trust terms can also control how the proceeds are distributed. With this type of trust, you don't retain any incidents of ownership in the life insurance contract, and premiums are generally paid with assets that are gifted to the trust using the annual gifting exclusion ($17,000 per donee in 2023.) Premiums can also be paid from other assets held in the trust (i.e., cash or other investable assets), assuming the trust is funded with these types of assets.

This type of trust allows you to receive income from the assets in the trust for a set period of time. After that time, the assets are passed to the beneficiaries with minimal or no gift tax obligations.

Placing a personal residence in a QPRT allows you to transfer ownership of your home to beneficiaries with reduced potential gift tax liability while continuing to live in the home. If you die before the trust expires, then the residence is included in your estate.

Charitable remainder trusts allow income from the assets to benefit you or your beneficiaries for a chosen period of time not to exceed 20 years or your lifetime. Any assets that remain in the trust at the end of the period or at the time of your death are left to the charity of your choice, allowing you to support your favorite cause and make a larger impact.

Think of a charitable lead trust as the opposite of a charitable remainder trust. Income from the assets goes to the charity of your choice. When the trust expires after a set period of time or at the time of your death, the assets are left to beneficiaries.

First passed in 2019, and a successor bill in 2022, the Setting Every Community Up for Retirement Enhancement (SECURE) Act made significant changes to the distribution requirements when a trust is a beneficiary of a retirement account. This is a complex situation, and you should consult with your tax and/or legal advisor on the distribution requirements.

In the right situation, an irrevocable trust can be a great tool for protecting your assets, reducing taxes or transferring wealth. It can be a vital tool to include in your financial strategy, especially when it comes to managing your estate and the assets you pass on to any beneficiaries.

To understand if an irrevocable trust is right for you, connect with a financial advisor to gain insight into how an irrevocable trust can factor into your future plans. They, along with an attorney, can help you set one up if you decide it's the right option for you and your financial needs.