When Is an Irrevocable Trust Not Recommended?

A trust is a fictional legal entity that holds property for a given purpose. People may establish trusts for the benefit of a charity, for the handicapped who cannot hold property in their own names lest it disqualify them for need-based benefits such as food stamps and Medicaid, or for the benefit of family members.

Types of Trusts

• Trusts come in two main categories: revocable and irrevocable. In a revocable trust, the grantor, or original owner of the assets, retains control of the assets. He can dissolve the trust, change the beneficiary or amend the language of the trust. With an irrevocable trust, the owner gives up control of the trust, permanently and irrevocably.

Estate Tax Implications

• Many affluent families use irrevocable trusts to hold assets to get them out of the estate. The IRS does not consider assets held within an irrevocable trust to be part of the taxable estate. The assets therefore escape the effects of the federal estate tax, which, beginning in January 2011, will levy a 55 percent tax on all personally owned assets over $1 million upon the owners' death, with the exception of transfers to surviving spouses and charitable gifts.

Asset Protection Planning Applications

• Affluent and wealthy families also frequently use irrevocable trusts to shield assets from the potential claims of creditors. Since the grantor has no control over the property, no court can order the grantor to transfer assets to a plaintiff in a judgment or in bankruptcy. Some grantors will structure trusts to provide them with a stream of income, which can be attached by a plaintiff. The corpus -- or principal within the trust that generates the income -- cannot be attached by creditors. Assets within a properly structured irrevocable trusts are therefore generally noncollectable.

Irrevocable Life Insurance Trusts

• The irrevocable life insurance trust, or ILIT, is frequently used by financial planners and attorneys to hold a life insurance policy for the purpose of funding a cash benefit for the payment of final expenses and any expected estate taxes. This technique accomplishes a number of objectives: It provides for tax-free cash when the estate needs to be 55 percent liquid to pay the estate tax; it allows the family to leverage its cash savings to provide the most cash possible at life expectancy or before; and it protects the family from having to sell land, homes, small businesses and other liquid assets in order to pay the estate tax. Finally, it gets the life insurance policy out of the estate. Otherwise, the IRS would levy the 55 percent estate tax on the death benefit of the policy itself.

Disadvantages of the Irrevocable Trust

• The irrevocable trust is just that: Irrevocable. Once the asset has been transferred to an irrevocable trust, there is no way to undo the transaction. If there is any possibility you will need the asset for personal use, or if you simply wish to maintain control of the asset, the irrevocable trust may not be a good match.