Living trusts are popular vehicles for individuals who hope to avoid having their estates go through the probate process when they pass away. If, during your lifetime, you transfer ownership of all your assets into a trust, you own nothing that requires probate when you die. Large differences exist between revocable and irrevocable trusts, however. They both avoid probate, but with the former, you maintain control over your assets while you’re alive. With the latter, you relinquish control for the rest of your life.
The creation of an irrevocable trust involves setting up a legal entity, other than yourself, to own your assets. You then transfer title of your assets from your name into the name of the trust. Once you’ve done this, you lose the right to take any of the assets back again. If an unforeseen catastrophe occurs and you need to put your hands on $50,000 in a hurry, you can’t access what you gave to the trust. The trust remains intact until your death, when its contents are dispersed to your beneficiaries according to your directives. Once you establish the trust and name your beneficiaries, you can’t change those terms either. It’s not like a will, which you can revoke and rewrite to accommodate changes in your life.
Since the irrevocable trust is a legal entity and can’t make decisions for itself, you need an independent trustee to oversee the assets your trust now owns. You have the right to name the trustee, just as you would name an executor for your will. The trustee oversees distribution of the trust assets to your beneficiaries when you die. She can transfer trust-owned assets from one investment institution to another. She can sell existing assets and buy new ones, all in the name of the trust. Depending on the extent of your assets, that’s a lot of power to give to one individual, but you can name a “trust protector” in addition to your independent trustee as a sort of watchdog. A trust protector has the right to remove a trustee for wrongdoing and name another individual instead. You can set up your trust to require the signatures of both your trustee and your trust protector for all trust transactions.
In exchange for giving up control of your assets, they become safe from your creditors, including any liabilities from lawsuits filed against you. For some wealthy individuals, the greatest advantage might be that your trust does not have to pay estate taxes on your assets when you die. As of 2011, estates valued at more than $5 million lose 35 percent of their value to federal estate taxes, and some individual states impose estate taxes as well. But if your irrevocable trust owns all your valuable assets, they do not count as part of your estate, so there is nothing to tax.
The assets you transfer into your trust might be subject to federal gift tax, because you effectively gave away your assets to this legal entity when you transferred them. As of 2011, the Internal Revenue Service allows you to give away up to $5 million during your lifetime before you have to pay a gift gift tax. Anything you transfer to your trust in excess of this amount is subject to tax at the rate of 35 percent. Clever estate planning can reduce this impact, and the tax rate and exemption amount can change yearly. If you’ve got significant assets that might cross this threshold, consult with an attorney.