An irrevocable trust is a powerful estate planning tool with many benefits; with that power, it is understandable that it also has some disadvantages. Knowing the disadvantages of an irrevocable trust will still help you understand whether this is the appropriate estate planning tool for you. The most common irrevocable trust disadvantages are listed below.
- Less flexibility. As mentioned before, once you put up an irrevocable trust, it will be very hard for you to change any of its terms or provisions. This is certainly a big disadvantage for irrevocable trusts since the future can be fairly uncertain. For instance, the irrevocable trust you set up in favor of your girlfriend or wife as beneficiary might turn out to not be a very good idea once you start going your separate ways.
- Limitations on control of the assets. Properties and assets placed in the irrevocable trust are, technically and legally speaking, no longer yours. They already belong to the irrevocable trust and will be distributed by the trustee to the beneficiaries in accordance with the trust provisions. Thus, the grantor will no longer be able to control the assets transferred to an irrevocable trust. This means that the grantor will be prohibited from selling or disposing the assets placed in an irrevocable trust.
- Legal fees. Not having an irrevocable trust is free, while setting one up may cause you to incur legal fees.
- Management fees. Most irrevocable trusts don’t have legal fees, as you would have a relative such as your child manage it. But if you have to hire an outside trustee such as a trust management company, you may incur management fees.
- Possibility of triggering a gift tax. Irrevocable trusts are often utilized to save on estate taxes. But while you might be able to save on estate taxes, you may still have to deal with the possibility of gift taxes on the assets you transfer to the irrevocable trust once you go over a certain threshold.
- Income tax issues for non-grantor trusts. A non-grantor irrevocable trust that earns income is taxed separately from the grantor. The income tax rate for certain irrevocable trusts, however, is usually higher than that for individuals. Hence, this is another significant disadvantage for an irrevocable trust, unless it’s a grantor trust.
- Increased tax administration costs. Maintaining a certain kinds of irrevocable trust may entail the payment of additional costs and expenses related to tax administration. For instance, unlike a revocable trust, an irrevocable trust that earns income may be required to file a separate tax return. The preparation and filing of such returns would, of course, entail additional service costs.
- Complexity. Are there situations wherein a beneficiary of an irrevocable trust can still be removed or replaced? How do you end an irrevocable trust that no longer serves its purpose? What are the possible tax implications of the irrevocable trust? These are complicated questions involving an irrevocable trust that a layperson cannot answer on his own. Complexity is another irrevocable trust disadvantage that can only be addressed with legal knowledge and expertise.
Trusts in general
By now, you already know what a trust is, so a quick refresher will suffice.
A trust is a legal arrangement wherein a person called the “trustor” or “grantor” transfers the legal title to certain properties and assets to another person called the “trustee” who, in turn, holds and manages the trust assets in favor of a third person called the beneficiary.
There are lots of possible reasons why one would want to establish a trust. Most of them involve complex estate planning strategies aimed at achieving specific financial goals. As such, establishing a trust almost always requires the assistance of a competent trust lawyer.
Revocable vs. Irrevocable
A trust may be revocable or irrevocable.
In a revocable trust, the grantor retains the power to vary and modify the terms of the trust he/she established. For example, the grantor could choose to remove some assets in the trust or to change the designated beneficiaries. The grantor may even choose to dissolve the trust itself.
The opposite is true for an irrevocable trust. Once a grantor creates a trust with irrevocable terms, he/she can no longer change its provisions. The grantor will generally not be able to remove properties placed in the irrevocable trust. Likewise, the beneficiaries can no longer be changed by the grantor.
As you will learn later on, being inflexible is one of the biggest irrevocable trust disadvantages. Once an irrevocable trust is established, the grantor will have to face the disadvantage of being unable to modify its terms as he likes. The irrevocable trust once created will have to stay as it is.
Is an irrevocable trust right for me?
An irrevocable trust might have some disadvantages, but this does not necessarily mean that it can never be the best estate planning choice under the right circumstances. Knowing what these circumstances are requires an evaluation of an individual’s unique needs and other concerns. This can be done through a consultation with an experienced and qualified trust and estates lawyer.
If you are looking for a competent New York trust attorney to evaluate your current situation for the establishment and creation of an irrevocable trust, you can call the Law Offices of Albert Goodwin at 718-509-9774.