Almost all trusts are designed to spend at least part of their lifespans as irrevocable trusts. In contrast to a revocable trust, the grantor of the trust cannot unilaterally undo an irrevocable trust. Once the trust is created and the grantor puts money or other assets into it, it's beyond the grantor's reach.
Why would a grantor choose to create an irrevocable trust? The most obvious reason: If the trust is designed to continue after the grantor's death, the grantor will usually wish to ensure that no one can end or modify the trust in a manner contrary to the grantor's instructions. However, there are several reasons why someone might want to make a trust irrevocable, even during life. The creation of an irrevocable trust may represent a gift to the trust's beneficiary, which may have a positive impact for income and estate tax purposes.
Say, for example, that you had bought shares of Marathon Oil (NYSE:MRO) or Wheeling Pittsburgh Corporation (NASDAQ:WPSC) at the end of 2005, and you now wanted to sell them. If you simply sold the stocks, you would likely create short-term capital gains that would be taxed at your own tax bracket. If, on the other hand, you gave that stock to someone else, and that person sold it, the tax would be based on that person's tax bracket, rather than yours. Because giving stock to someone outright would make it impossible for you to have any say over what is done with the proceeds, you might prefer to use an irrevocable trust to state your wishes about how the trust beneficiary could use the proceeds.
In addition to effectively transferring income tax liability from one person to another, irrevocable trusts can also be a good way to avoid or reduce estate taxation. As the next article describes in further detail, life insurance is particularly well-suited for use in an irrevocable trust, and an appropriately drafted trust can create huge savings for large estates.
Irrevocable trusts usually have provisions that guide the trustee in using trust assets for the benefit of its beneficiaries. One of the most commonly used provisions is the ascertainable standard. It allows distributions for expenses related to health, education, maintenance, or support of the beneficiary. This standard is flexible enough to give the trustee wide latitude in determining when to make distributions. Some people prefer to include more objective directions, such as specific dates or ages at which to make distributions. Because the grantor cannot generally alter any trust provisions, even if future circumstances change, it is important to consider both present and future needs in drafting the trust.
Read more in our series about trusts:
- A Trust for All Seasons: Introduction
- A Trust for All Seasons: Revocable Trusts
- A Trust for All Seasons: Life Insurance Trusts
- A Trust for All Seasons: Personal Residence Trusts
- A Trust for All Seasons: Charitable Trusts
- A Trust for All Seasons: Special Needs Trusts
You're never too young or too old to start your retirement planning. Why not get your feet wet with a risk-free trial to Motley Fool Rule Your Retirement?
Fool contributor Dan Caplinger welcomes your comments at [email protected]. At the time of publication, he did not own shares of any company mentioned in this article.
