How Does an Irrevocable Trust Work?

An irrevocable trust allows you to detail how you want your assets distributed to your beneficiaries. While similar to a will, an irrevocable trust is set up slightly differently. This article will explain how an irrevocable trust works and how it might be advantageous to you.

Unlike a revocable trust which allows the grantor to make changes to the trust during the grantor’s lifetime, an irrevocable trust typically cannot be changed, expanded, or terminated. As such, an irrevocable trust can prevent the sale of assets to address financial issues, but it can also provide substantial protection from creditors which can be attractive to those people who have accumulated a decent amount of wealth.

Just like a revocable or living trust, an irrevocable trust consists of a grantor, a trustee, and at least one beneficiary. However, unlike with a revocable or living trust where the grantor can also be a named beneficiary, this is not the case with an irrevocable living trust. The trustee, who can also be a named beneficiary, is responsible for managing the trust. The beneficiaries are those relatives, friends, or charitable organizations who will receive assets from the trust.

Upon transferring assets into the irrevocable trust, the grantor loses control of the assets. The grantor no longer holds legal possession of the assets, which means the assets do not have any impact on the grantor’s wealth, tax liability, or value of an estate. This is also why the grantor cannot be a beneficiary of the trust.

The tax advantages of an irrevocable trust make it a popular financial strategy to protect the value of assets. As with revocable trusts, the grantor is also able to define the terms for how each beneficiary receives the specified assets that are protected by the trust. For example, a popular term written into an irrevocable trust stipulates at what age a beneficiary can receive the proceeds generated by the sale of assets. You also receive legal protection from future lawsuits and creditors.

The word “irrevocable” is a bit misleading when it comes to setting up a trust. You can make changes, but you have to get the permission of each of the beneficiaries named in the trust. A single dissenter can prevent you from changing or dissolving an irrevocable trust.

State law also plays a role in making changes. For instance, Missouri law allows grantors to change the terms of an irrevocable trust if the assets protected in the trust are not worth enough money to make it reasonable to administer the assets held in the trust. States such as Virginia and New Hampshire permit changes under a legal process called decanting which alters a trust by implementing updated terms.

Because an irrevocable trust is difficult to change, you might be better off placing your assets in a living or revocable trust. However, creating a trust that is difficult to change works in a few circumstances. First, it is a viable asset protection option for someone who has amassed a decent amount of wealth. Second, irrevocable trusts are an effective way to protect assets for a disabled dependent. Third, a trust that is difficult to alter protects assets that might be dispersed because of the results of a civil lawsuit.

If you're considering the formation of an irrevocable trust consulting with an estate planning attorney can help you understand how irrevocable trusts work and whether you want to place your assets in an irrevocable or revocable trust.