Lots of people get living trusts. For many folks, they’re a better way to avoid costs, disputes and delays when they shuffle off this mortal coil, as opposed to just having a will (or nothing at all) and going through probate.
And most of these trusts are revocable. That means that if the person or couple who created the trust wants to change it later, or even cancel it completely, they can. That makes it a very flexible type of arrangement. Circumstances changed? Just change the trust.
Occasionally, though, people set up irrevocable, instead of revocable, trusts. They intentionally surrender the right to change the terms of the trust, forever. It is set in concrete the moment it is created. It is designed not to be flexible.
So, why would anyone want to do that?
There are several good reasons they might. It used to be that estate taxes were the most common reason. For example, you could put an asset that you think will continue to go up in value, such as a stock, a business, or a piece of real estate, into an irrevocable trust for the benefit of your children. For purposes of estate tax, the value would be “frozen” at the value the asset had when you put it into the irrevocable trust, instead of the presumably higher value it would have later on, when you died.
For example, let’s say I have a rental property that is worth $500,000. I put it into an irrevocable trust for the benefit of my children. Years later when I die, it is worth $850,000. If I did the trust right, it only counts as a $500,000 asset for tax purposes, even though my children got an asset worth much more than that. I just legally passed the difference of $350,000 to my heirs, tax free.
And for some people, that is still a useful strategy. But at the moment, the “exclusion amount” for federal estate tax is almost $12 million, so there aren’t very many people who need to do things like that. As I write this, the House Ways and Means Committee in D.C. is trying to drop that exclusion amount to $6 million, but that would still mean a fairly small number of people need an irrevocable trust to freeze values.
Speaking of the Ways and Means Committee bill, there might be a lot of wealthy people creating irrevocable trusts before the end of this year. The exclusion amount for the gift tax is the same as the exclusion amount for the estate tax. If you give your children $100,000 while you are alive, it eats up part of the exclusion amount for gift tax, and part of the exclusion amount for estate tax as well.
So let’s imagine you have $10 million in assets, and you are a single person. This new tax bill passes, and it will be effective on January 1, 2022. For a few more months, the exclusion amount is still $12 million. So you put your assets into an irrevocable trust for the children, and it eats up part of the exclusion amount, but that’s okay because the exclusion amount is still more than the $10 million you are putting in. On January 1, the exclusion amount drops to $6 million, but that doesn’t matter because you already completed the gift.
(By the way, these tax strategies are very complicated, so work carefully with your accountant if you are thinking of doing this. And after all, if you are anywhere near $6 million, you can probably afford an accountant.)
“But Kirk,” you say, “I don’t have anywhere near $6 million. Heck, I don’t have half that. Is there any reason I would ever consider an irrevocable trust?” Well, possibly.
There are certain types of irrevocable trusts which are called asset protection trusts. These can be useful for people who are at high risk for liability, such as doctors and engineers. The purpose here is not particularly to save on estate taxes, but to shield assets in case you make a mistake in the future. Alaska was one of the first states to have asset protection trusts, although a lot of other states are scrambling to put them in place. Incidentally a lot of people try to create these asset protection trusts when it is too late, and they already have a liability. It has to be done before the accident happens.
Here’s another possibility: You are trying to qualify for Medicaid, because you think you may end up in a nursing home in the future, but you have too many assets to qualify. One possible strategy (among many) is to put some of your assets into an irrevocable trust. If the trust is done right, it triggers the “five-year look-back” and once five years passes, they won’t count that transfer against you.
And a lot of times, irrevocable trusts are done by someone who wants to protect themselves against future mistakes in judgment. For instance, I have set up irrevocable trusts to protect the assets of someone who is getting remarried, and wants to make sure that the new spouse doesn’t get the assets that they want going to their children from the first marriage. I have done irrevocable trusts for people in the early stages of progressive dementias such as Alzheimer’s, who are concerned that when they reach a certain point they may make poor decisions, and they want to protect themselves against that.
When you think about it, there are a lot of reasons someone who is not fabulously wealthy might want to set up an irrevocable trust. But it is a big step. It does mean giving up control of assets that you worked hard to earn and to preserve, and it generally means that if things change in the future, you may be locked into a plan that no longer makes sense.
Final caution: Even more than revocable trusts, it is critical that irrevocable trusts be done right. The consequences of doing them wrong can be devastating. If you think you may want to get an irrevocable trust, make sure you’re working with someone who knows what they are doing.
Kenneth Kirk is an Anchorage estate planning lawyer. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. In other words, don’t try this at home.
