Think of a trust as a large box that can hold any number and assortment of assets. That includes cash, certificates of deposit, securities, real estate, and even real property, just to name a few. The trust will have a set of rules governing what it can and can’t do, and it will list one or more beneficiaries, for whom the trust is intended to benefit.
Trusts can be either revocable or irrevocable, and the difference is self-explanatory; revocable trusts can be amended or revoked by the individual who created the trust (otherwise known as the grantor), while irrevocable trusts are set in stone and cannot be adjusted once they are officially organized. Some irrevocable trusts include clauses that allow modifications to be made at the discretion of the beneficiary (see ARS 14-10411 for Arizona), but only if the proper clauses were included in the trust documents. Generally, it is extremely difficult—if not impossible—to alter an irrevocable trust.
An irrevocable trust is considered a legal entity separate from the grantor, so any assets transferred from the grantor to the trust are permanently removed from the grantor’s estate. Usually, this is done to protect assets from liabilities that threaten the grantor’s estate, and protect the assets for the intended beneficiaries.
When used appropriately as part of a robust overall estate plan, irrevocable trusts can be a valuable tool. Following are four common benefits of an irrevocable trust.
Advantage: Protection from Lawsuits
If you work in a profession that puts you at risk for personal lawsuits, an irrevocable trust can legally separate assets from your estate, placing them out of the reach of any judgements against you. Since the trust is considered a separate legal entity, it will not be party to the lawsuit. For example, if you are subject to a malpractice lawsuit that exceeds the limits of your malpractice insurance, shifting your personal assets into an irrevocable trust means that the transferred assets cannot be seized, garnished, or frozen by the court.
Advantage: Protection from Creditors
Similarly, an irrevocable trust offers protection against credit claims. While a lien may be placed on your personal property and financial accounts can be garnished, creditors will not be able to go after anything transferred to the trust since you no longer own the assets. Even after your death, if your estate is deemed insolvent during probate and there are not enough assets to cover your liabilities, the property transferred to the trust is shielded from claims. Although you cannot reclaim the transferred assets, they would be safely preserved for your beneficiaries.
Advantage: Estate Taxes
In 2017, estates with assets in excess of $5.49 million (or $11 million for joint spouses) are subject to an estate tax (also referred to as a death tax, or inheritance tax). Depending on the size of the estate, the IRS can impose a tax as high as 40%, significantly limiting what you will be able to distribute to your beneficiaries. There are several ways to position your assets to avoid or minimize estate taxes, and an irrevocable trust can be a valuable tool as part of a comprehensive strategy to accomplish that. Any property you transfer to the trust will not contribute to the gross value of your estate for estate tax purposes, therefore limiting the value of your estate subject to the tax.
Advantage: Government Benefits
Many government benefit programs consider the value of your assets when assessing your eligibility. Even if the size of your estate doesn’t disqualify you for a program, it can impact the extent to which you qualify, limiting the value of potential benefits. For example, there are government benefit programs meant to assist with nursing home care, but they may hinge on the value of your personal assets, especially those assets that produce investment income. With an irrevocable trust, the funds owned by the trust would not be considered when assessing your eligibility for benefits, allowing you to qualify for such programs while still preserving assets that can be passed on to your beneficiaries.
Irrevocable trusts aren’t right for everyone, however, and they do possess a few drawbacks worth considering. Following are a few of the potential downsides of an irrevocable trust.
Disadvantage: Loss of Control Over Assets
The greatest downside of an irrevocable trust is the inability of the granter to resume ownership of transferred assets. If your financial situation or needs change in the future and require the assets held in the trust, it will be extremely difficult to regain control of the assets from the trust. Some irrevocable trusts include provisions that allow changes to be made with the permission of the beneficiaries, but even then, your ability to access the assets will hinge on that individual’s willingness to let you alter their inheritance. If there is any chance that you will need to access the assets in the trust in the future, or that you may need proceeds from the trust to supplement future income, consult with a qualified estate attorney to ensure the trust is drafted with clauses to make these options possible.
Disadvantage: The Ever-Changing Legal Landscape
The legislative landscape is always changing, meaning there is a very real possibility that any protections or guarantees offered by federal or state law today will not be around in the future. Most legislation doesn’t offer “grandfathering” clauses, either, so trusts created in 2017 may be subject to different rules and regulations in 2027, negating currently perceived benefits. While wills and revocable trusts can be altered over your lifetime to address these changes, an irrevocable trust is extremely difficult to adjust, leading to a very real chance that you may be unable to make necessary changes down the road if the laws regarding estates and probate change.
Disadvantage: Five-year Ineligibility Period for Medicaid
Regarding spouses who require nursing home care, some states offer protections that allow your spouse who is living in a nursing home to qualify for benefits while retaining joint control of assets. These protections are forfeited, however, for five years following the transfer of assets into an irrevocable trust (or transferring to children, for that matter). Consult an estate attorney, especially one who specializes in elder law and long term care, so determine which, if any, restrictions exist in your state.
Call Arizona Estate Attorney Dave Weed at (480)467-4325 to discuss your case today.
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