Irrevocable trusts are an important tool in many people’s estate plan. They can be used to lock-in your estate tax exemption before it drops, keep appreciation on assets from inflating your taxable estate, protect assets from creditors, and even make you eligible for benefit programs like Medicaid.
When it comes to estate tax planning, the key is to take assets out of an estate, reducing the chances of having to pay estate taxes. For estate tax purposes, placing assets inside a properly drafted irrevocable trust has the same effect as giving it to an heir directly. If your estate exceeds $11.7 million (including all assets—don’t forget about life insurance), then an irrevocable trust may be a smart move. Many states with estate taxes also have far lower exemptions than the federal estate tax, but Virginia does not have an estate tax for now.
Asset protection is another potential benefit of an irrevocable trust. If you are sued, any assets in the trust can be beyond the reach of a legal judgment, a worthwhile strategy for people who have a greater likelihood of being sued because of their profession. However, the irrevocable trust must be created before a cause of action arises. A physician who transfers a million-dollar home into an irrevocable trust on the eve of a malpractice lawsuit, for instance, may be challenged with having made a fraudulent transfer to the trust.
While asset protection is great, there is a cost to an irrevocable trust’s protection: You have to give up control of the assets and over the trust. Most people name a trusted family member, business associate, or professional to serve as the trustee. Consider naming a successor trustee, in case the original trustee is unable to fulfill their duties.
Despite the name, changes can be made to an irrevocable trust. Trust documents can designate a “trust protector,” who is empowered to make certain changes to the trust. Many states have regulations concerning changes to the administrative aspects of a trust, and a court has the power to make changes to a trust. In Virginia, you can even utilize a Non-judicial Settlement Agreement to make some limited changes while avoiding a court.
Worried you will lock up your real estate in a trust? Don’t fret. An irrevocable trust can buy and sell property. If a house is placed into the irrevocable trust, the house can be sold, as long as the proceeds go into the trust. Your trustee can use the proceeds from selling a house to buy a different house. Be sure the new house is titled correctly: owned by the trust, and not by you.
For highly appreciated assets in an irrevocable trust, you can utilize an asset swap to get your children a more favorable tax treatment. If the trust holds an asset that has become highly appreciated, you can swap cash for the asset and the basis on which the asset’s capital gains is calculated gets adjusted to its fair value if it is in your estate when you pass, eliminating any capital gains on a later sale of the asset. The amount of cash you substituted for the asset is still in the irrevocable trust and is not part of your estate for federal estate tax calculations.
It is rarely advisable to render yourself insolvent moving assets into an irrevocable trust. You generally want to make sure that you have enough assets to live on before putting anything into the trust because you are giving up control and cannot rely on those assets to support you if you want to maintain most benefits your irrevocable trust provides.
Transferring assets to an irrevocable trust can make you eligible for means-tested government programs, like Medicaid and Supplemental Security Income. Assets and income sheltered within an irrevocable trust generally are not counted as personal assets for these kinds of program limits. However, Medicaid has a look-back period, so it is important to transfer any substantial assets to the irrevocable trust well before you need to apply for Medicaid.
Always talk with your estate planning attorney first. Not every irrevocable trust satisfies each of these goals. It is also possible that this type of trust trust may not fit your needs. An experienced estate planning attorney will be able to create a plan that suits your needs best for tax planning, asset protection and legacy building. For more information on Irrevocable Trusts, here is another article: The Value of Using Irrevocable Trusts in Medicaid Planning.
Reference: Think Advisor (Dec. 16, 2020) “10 Facts to Know About Irrevocable Trusts”