Types of Irrevocable Trusts
There are two main categories of trusts: living trusts and testamentary trusts. (A living trust can be either revocable or irrevocable).
With all of this terminology, it's easy to feel overwhelmed. The good news? We're here to break down the different types of irrevocable trusts and who they're most beneficial for.
Of course, the type of trust you need is best left to the opinion of an experienced attorney, but learning about them is a great first step.
What is an Irrevocable Trust?
An irrevocable trust is an estate planning tool that helps the trust’s creator distribute assets to the appropriate beneficiary.
It's called an irrevocable trust because, after it is created, the person who established it cannot change it.
Benefits of an Irrevocable Trust
Comparing irrevocable trusts to a revocable trusts, most types of irrevocable trusts have benefits including:
Beneficiaries don't have to pay taxes on assets received from an irrevocable trust
It protects assets from creditors
Keeps assets out of probate (and, therefore, out of the public eye)
What Are the Types of Irrevocable Trusts?
When picking the perfect trust for your estate plan, it’s more than just choosing between revocable and irrevocable trusts.
There are several types of irrevocable trusts, here are the most important ones you need to know about.
Irrevocable Life Insurance Trust (ILIT)
An irrevocable life insurance trust is a living trust where the creator puts their life insurance policy (or policies) into a trust.
By putting your life insurance policy in an irrevocable life insurance trust, you can help loved ones avoid up to 50% federal estate tax.
With an ILIT, the trust owns the life insurance policy, and the death benefit proceeds will not count towards your taxable estate. You can name the same beneficiaries as with other trusts, and they get the policy contents tax-free.
An irrevocable life insurance trust is most beneficial if your net worth (including life insurance policy) is above the IRS’ exclusion amount. It usually changes yearly of $12.06 million for a single person.
Medicaid Asset Protection Trust (MAPT)
Medicaid is an income-based government assistance program. To be eligible, you must be considered at or below low-income and fall under one of the qualifying health categories outlined on benefits.gov.
Because of this income requirement, many people don’t qualify for Medicaid. Setting up a medicaid asset protection trust can make you eligible for Medicaid. To do this, you need to structure the trust in a way that brings your net worth and income below the threshold.
The benefit of setting up a Medicaid asset protection trust is that you can qualify for government assistance for healthcare and nursing homes without paying for all of it out of pocket. This allows you to leave more money to beneficiaries.
Spousal Lifetime Access Trust (SLAT)
A spousal lifetime access trust is set up for the benefit of the grantor’s spouse. It can pay out, or gift, up to $20,000 per year tax-free. The spouse may choose investments and trustees.
The spouse is the primary beneficiary, so they may share the distributed property with the spouse who created the trust should they run out of assets.
The trust continues to pay out to the beneficiary's spouse until their death or until funds are depleted. If assets remain in the trust after the beneficiary spouse dies, they are immediately transferred to descendants or other secondary beneficiaries.
Establishing an irrevocable trust in the form of a charitable trust has a couple of key advantages. It has tremendous tax benefits for your beneficiaries. It also helps ensure you meet your donation goals for optimal income tax deductions.
There are two types of charitable trusts: a charitable remainder trust and a charitable lead trust.
Charitable Remainder Trust
A charitable remainder trust works by paying the beneficiaries for a set amount of time. After the time limit has been reached, the remainder of the trust’s contents will transfer to the named organization as a charitable donation.
There are two primary ways charitable remainder trusts are set up:
Charitable annuity trust - Under this type of charitable remainder trust, the beneficiaries get out a set amount each year for a specified amount of years before the remainder goes to a charity.
Charitable Unitrust - A charitable unitrust pays out annually like an annuity trust, but it pays a percentage of the value of the trust rather than a set amount.
Charitable Lead Trust
During the life of a charitable lead trust, a set percentage of the trust is paid to one or more organizations of your choice.
After the specified term is over, the remainder of the assets in the trust will be allocated to the designated beneficiaries.
A testamentary trust is an inherently irrevocable trust that is meant to protect and distribute assets to beneficiaries. It is part of your will and doesn’t become active until after you die.
With a living trust, the assets you put into it belong to the trust itself. Because of this, they can avoid probate since you are not the owner. With a testamentary trust, however, the assets are in your name at the time of death. This means that the contents of the trust will have to go through probate.
Testamentary trusts are funded by the assets of the decedent per their wishes detailed in the will.
Benefits of a Testamentary Trust
Despite not having the ability to avoid probate, a testamentary trust still has many benefits.
Asset management for beneficiaries - this is useful if a parent passes away before their child is still a minor. A testamentary trust will protect the assets the parent left until they can be transferred to the child.
Reduced estate taxes on assets transferred to beneficiaries - estate taxes can reach upwards of 50%. A testamentary trust allows beneficiaries to avoid a large portion of this.
Paid for by the decedent’s estate - The cost of forming a testamentary trust comes out of the remaining assets left by the person who planned the trust. Because of this, there are no costly, upfront setup fees like with other trusts.
Why Would You Want to Establish an Irrevocable Trust?
The idea of an irrevocable trust is to create generational wealth. It helps save your beneficiaries thousands of dollars in estate taxes and allows them immediate access to many assets due to probate avoidance.
What Type of Irrevocable Trust is Right for You?
There are many types of irrevocable trusts that benefit your loved ones after you die, and more that can benefit you during your life. They all have nuances that can be confusing for the average person.
We highly recommend hiring an experienced estate planning attorney. They will be able to help you pick the best irrevocable trust(s) for your specific goals. To speak with an attorney about which one is right for you, send us a message or call today!