Clients often ask about whether they should have a revocable or an irrevocable trust. As a general rule, I like flexibility – we have no clue what a client may face in 5 or 10 years down the road. That said, there are some advantages to using an Irrevocable Trust.
Let’s first start with what a trust is. Basically, it is an agreement between three parties: the grantor, the trustee, and the beneficiary. The grantor is the person that created the trust. The trustee is the person that manages the trust pursuant to the terms of the trust agreement, and the beneficiary is the person who receives the benefit of the trust assets.
Although revocable trusts are great tools for probate avoidance or spendthrift protection, they do have certain limitations. If you are looking for more complex planning, you may need to look at an irrevocable trust.
The Benefits of Irrevocable Trusts
- Minimizing Estate Taxes – The federal estate tax exemption amount is currently $12.92 million; however, it is set to decrease in 2026. Individuals with assets exceeding the estate tax exemption may have to pay taxes on the additional assets – the rates for which range from 18% to 40%. To minimize the burden, many wealthy clients use irrevocable trusts as part of a plan. Such trusts may include irrevocable life insurance trusts, charitable remainder trust, or a grantor retained annuity trust.
- Protection for Public Benefits – Senior clients often want to protect their assets from the cost of long-term care. Unless the client has a long-term care policy or sufficient assets to pay for their care privately, a Medicaid plan may need to be developed. Since Medicaid has strict income and asset limits, an irrevocable trust may be used to move assets to a trust for which the senior client is not a trustee or a beneficiary (although in some cases they may retain a right to distribution of income).
- Creditor Protection – Some clients need to be insulated from a potential lawsuit. These are often utilized by surgeons, architects and real estate developers to protect their life savings. To do so, they may use an irrevocable asset protection trust. Virginia does have a Domestic Asset Protection Trust statute, but other jurisdictions such as Delaware, Nevada, South Dakota, and Tennessee, have much more favorable asset protection trust statutes.
The Negatives of Irrevocable Trust
- Taxes – Depending on how the trust is drafted, you may face higher income taxes. It is important, as a result, to use an experienced trust and estate practitioner who can walk through income tax issues. In some cases, the trust may be considered a “Grantor Trust” such that the income stays with the grantor. In other cases, the trust will be a separate tax payer subject to fiduciary income tax rates. The benefit of the higher income tax hit, however, may be offset by the rationale driving the decision for an irrevocable trust.
- Loss of Control – In most cases, the grantor cannot maintain control over the trust. Although some provisions may be included to provide for some modification (i.e. the ability to add to a class of beneficiaries), the general rule is that the grantor will not be trh trustee, and that the terms of the trust are fixed.
- Untimely Conveyance – A court may reclaim assets that were transferred to a trust in contemplation of a lawsuit. For most states, there is a period of time for which the transfer of funds may be looked at by creditors before they qualify for asset protection. Most states require funds be transferred at least two years before litigation, however, some may require more. Virginia’s statute requires a five-year transfer period.
