Some of the most frequent questions I hear from clients in my estate planning law practice have to do with whether they should create an irrevocable trust. Here are five questions to ask when deciding whether or not an irrevocable trust would be a good addition to your estate planning strategy.
- What is your reason for creating an irrevocable trust? Before jumping in to create an irrevocable trust, talk to your estate planning attorney about your goals. The two most common reasons for creating an irrevocable trust are 1) to save taxes; and, 2) to preserve assets from the reach of creditors, including long-term care costs. Some typical tax savings trusts include irrevocable trusts that hold life insurance, trusts that pass assets to charity, or that are used to gift assets to family members. Irrevocable trusts that are created for long-term care planning purposes typically provide for an income stream to the trust maker but forbid any access to the principal of the trust.
- Do you have the ‘right’ assets to fund an irrevocable trust? If your goal is to preserve your assets against long-term care costs but your assets consist mostly of IRAs or other qualified retirement funds, transferring those accounts to an irrevocable trust is not a good plan. The transfer of an IRA out of the name of the IRA owner is a taxable event. For example, if you have a $500,000 IRA and you move it into the name of your irrevocable trust you will be deemed to have $500,000 of taxable income. This will mean an income tax bill in the neighborhood of $150,000 or so – not a good result.
- Will you need to have access to the principal? A hallmark of most irrevocable trust planning is that once you transfer an asset to the irrevocable trust, you cannot get it back. Understandably, many people are reluctant to transfer their money or investments to an irrevocable trust. Transferring your home to an irrevocable trust can be a good way to protect property from medicaid and preserve the value of the home from having to be spent down on long-term care costs without really impacting your day to day life. You may continue to live the home and even pay all the bills. If the property is rental real estate, you can continue to receive the net rental income. However, if the property in the irrevocable trust is sold, you would not have access to the sale proceeds, which would continue to be held in the irrevocable trust.
- What are the consequences of transferring your assets to an irrevocable trust? Before transferring assets to an irrevocable trust, you should understand the consequences of the transfer on your estate plan and your inheritance planning. (See number 2 above.) For example, even though the transfer of a home to an irrevocable trust will not result in an immediate tax consequence, there could be later tax consequences. Such a transfer may mean that the inheritors of the house will not be entitled to a stepped-up basis in the property when the trust maker passes away. This may result in a significant capital gain tax upon the sale of the property that would have otherwise been avoided if the property had not been transferred or if the trust included certain provisions. Similarly, if the home is sold while the person who transferred it to the irrevocable trust is still living, there may be capital gain tax payable on the sale that would have been avoided if the property had not been transferred to the irrevocable trust. There can be non-tax consequences as well. Transferring a home to an irrevocable trust usually makes it difficult to obtain a mortgage or home equity loan on the property. This could impact the ability to make repairs or improvements to the property.
- Is there another way to accomplish your goal? Since creating and funding an irrevocable trust can be complex (and expensive), explore whether there are other options for achieving your desired result. For example, gifting the home, vacation home, or rental property directly to children subject to the parent’s right to live in the property (typically called a life estate deed) rather than to an irrevocable trust, might be a better way to preserve that property from spend down for long-term care in your situation. If your goal is to benefit charity, maybe a donor-advised fund through one of the larger brokerages may be a simpler, easier option than creating an irrevocable charitable trust.
As with all estate planning, whether or not a particular type of trust or other planning is right for you depends entirely on your unique situation. Speak with an experienced estate planning attorney, a lawyer for wills and trusts, about your situation and your goals and don’t forget to ask the above five questions.
Attorney Suzanne R. Sayward is a partner with the Dedham firm of Samuel, Sayward & Baler LLC which focuses on advising its clients in the areas of estate planning, estate settlement and elder law matters. She is certified as an Elder Law Attorney by the National Elder Law Foundation, a private organization whose standards for certification are not regulated by the Commonwealth of Massachusetts. This article is not intended to provide legal advice or create or imply an attorney-client relationship. No information contained herein is a substitute for a personal consultation with an attorney. For more information visit www.ssbllc.com or call 781/461-1020.
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