Define Irrevocable Trust
Irrevocable trusts are an effective estate-planning tool; however, they are not widely understood or used. These tools have similarities to their counterpart, revocable trusts, but also differ in many ways. Irrevocable trusts can be set up for a wide variety of purposes depending on the need. However, despite the purpose, all irrevocable trusts have the same basic concepts and a common benefit of reducing estate taxes.
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Definitions
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Several terms are unique to trusts. The “grantor” is the person donating the assets into the trust. The “trustee” is the person or institution whom the property is being transferred to. The “beneficiary” is the person whom the trust benefits. The “corpus” is the asset(s) in the trust. The “trust agreement” is the written document that governs the entire trust, including the trustee’s powers and beneficiary designations.
Transfer of Ownership
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For irrevocable trusts to be fully effective, there must be a transfer of ownership. By taking the assets out of the grantor’s name and putting it in the trustee’s name, the grantor reduces his gross estate and therefore, reduces his estate tax liability. If the grantor does not technically own the assets, the IRS cannot tax it.
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Irrevocability
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The main difference between revocable trusts and irrevocable trusts is the ability to alter the terms of the trusts. Revocable trusts can be changed at any time; however, because the grantor is retaining rights, the assets in the trust are considered in his gross estate. Irrevocable trusts are exactly the opposite: the grantor loses the right to change the terms but reduces his gross estate.
Benefits
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The main benefit of an irrevocable trust is the reduction of estate tax liability. Individuals set up these trusts for other reasons as well, including, but not limited to: protection of assets, providing for families, donations for a charity or providing for heirs with handicaps. A special type of trust called an irrevocable life insurance trust (ILIT) is formed for the extra benefit of providing life insurance benefits to the beneficiaries. Assets in irrevocable trusts also avoid probate, which can be a costly procedure after the death of the grantor.
Estate Tax Avoidance
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As mentioned before, the main benefit of an irrevocable trust is its estate tax benefits. This is more widely understood when the estate tax is explained. For 2010, no estate tax exists which might seem like a fortuitous event. However, the estate tax is scheduled to come back in 2011 at a hefty 55 percent. Not only is the tax rate up from its previous 45 percent in 2009, the annual exclusion amount (amount which triggers tax liability) is scheduled to drop to $1 million from its previous $3.5 million. This means a much wider portion of the American population will be subject to estate tax at a much higher rate. Congress does have the power to change this before 2010 is over.
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References
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