6 Types of Irrevocable Trust and their Benefits

A living trust is also called a revocable trust, because it enables the person who sets up the trust to subsequently make changes to it, including revoking it. This section discusses irrevocable trusts, which are similar in that they're also legal entities that hold assets for its beneficiaries and act as instructed by their grantors, but different in that the contributions are irrevocable and therefore cannot be taken out of the trust by the grantor. Given this downside, why would anyone opt for an irrevocable trust rather than a revocable trust? Because they offer tax advantages that revocable trusts don't, for example by enabling you to give money and assets away even before you die.

Of course, you can give away money while you're still living even without a trust.

However, there will be tax consequences if the amount is sufficiently large. You can give any amount to your spouse tax-free, and you can give up to $11,000 per year to anyone else without incurring a tax, but above this level you will incur a gift tax, and the amount will usually be the same as the estate tax you would have paid if you bequeathed the gift upon your death. Irrevocable trusts are a way to further reduce the bite of estate taxes.

The rest of this section describes some of the more common types of irrevocable trusts.

1. Charitable Remainder Trust

The beneficiaries receive the income and the charity receives the principal after a specified period of time. The grantor avoids any capital gains tax on the donated assets, and also gets an income tax deduction for the fair market value of the remainder interest that the trust earned. In addition, the asset is removed from the estate, reducing estate taxes down the road. While the contribution is irrevocable, the  grantor may have some control over the way the assets are invested, and may even switch from one charity to  another (as long as it's still a qualified charitable organization).

CRTs come in three types: charitable remainder annuity trust (which pays a fixed dollar amount annually), a  charitable remainder unitrust (which pays a fixed percentage of the trust's value annually), and a charitable pooled income fund (which is set up by the charity, enabling many donors to contribute).

2. Charitable Lead Trust

This is similar to a Charitable Remainder Trust, except that the charity receives the income and the beneficiaries receive the principal after a specified period of time.

3. Credit-Shelter Trust (also called a Family Trust or a Bypass Trust)

This is designed to enable a married couple to effectively double the amount they can protect from estate taxes by setting up a trust with an amount equal to the estate tax exemption ($700,000 in 2002). There are some important restrictions on such trusts, most notably the fact that they can only be funded with assets that the spouses own separately rather than jointly (although retitling circumvents this limitation).

4. Generation-Skipping Trust (also called a Dynasty Trust)

This enables a grantor to transfer up to $1 million (or $2 million for a married couple) to family members at least two generations younger (usually grandchildren). Grants in excess of this amount are subject to a 55% generation-skipping transfer tax.

5. Irrevocable Life Insurance Trust

This enables the shielding of life insurance from estate taxes.

6. Qualified Personal Residence Trust

This enables the shielding of a home from estate taxes.

Many of the same suggestions for living trusts also apply for irrevocable trusts: get help from a qualified professional; keep all the relevant documentation in a safe place; choose the trustee carefully; and talk to the beneficiaries about the trust.
By InvestorGuide Staff

Copyrighted 2020. Content published with author's permission.

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