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The Irrevocable Trust

One of the most important estate planning tools ever devised is the Irrevocable Trust.  Here are some facts and comments about these trusts from the just-updated book, The New Book of Trusts (610 924 0515):

Q. What is an irrevocable trust?

A. Think of a trust as a box into which you can put all types of assets.  A revocable trust is like a "box with a string on it."  By "pulling on the string", you can recover the property you placed into the box or change the terms of the agreement you made when you set up the box.

If you "set you the box without a string" of if you "cut the string" you kept when you set up the box, your trust becomes irrevocable.  You can't revoke it.  You can no longer reach in and get back cash or other assets you put into the trust.  Nor can you unilaterally change the terms of the trust.

The term "irrevocable trust" is usually used to describe a "living" or "inter vivos" trust created during the lifetime of the grantor (that's you, the person who creates and funds the trust) that cannot be revoked, altered, amended, or terminated by the grantor.  The grantor transfers legal title to property (called corpus or principal) to the trustee (the person or parties) who hold(s) legal title to the property placed into the trust.  The trustee is responsible for administering that property for the benefit of the trust's beneficiary(ies) (the person(s) or party(ies) for whose benefit the trust was created).

Which strings you keep - and how many - will have a direct impact on whether or not you will be taxed on the trust's income and whether or not trust assets will be included in your estate for federal and state death tax purposes.  (If tax savings are not a major consideration, you may want to consider holding on to one or more of these powers).

Q. Why would I consider creating a trust that I couldn't revoke or amend?

A.No one would give up the right to recover cash and other property or change the terms of a trust - unless the stakes were very high.  Keep reading and you'll find - they are!

Of course, not everyone needs to set up an irrevocable trust.  No estate planning tool should be used just because it is popular - or even because it may save huge amounts of estate taxes.  Don't use an irrevocable trust unless it will accomplish a number of objectives that are very important to you.

The decision to use an irrevocable trust is really two separate decisions.  The first decision is whether or not to make a lifetime gift.  The second decision is whether to make the gift outright or in trust.

Many (perhaps most) gifts - either outright or in trust - are made from generosity or love.  But if you are looking for a less altruistic reason for making gifts, especially those to irrevocable trusts, the answers are usually, "to control the timing and conditions under which my beneficiaries will use and enjoy the gift" and "to save taxes."

Lifetime gifts can save death taxes (and income taxes) in a number of different ways:

First, the federal gift tax annual exclusion allows you to give $11,000 (increased from time to time for inflation) each year to as many different people as you like (or $22,000 if you are married and your spouse agrees to "split" the gifts for gift tax purposes).  Once you give it away, it can't be taxed.  When your estate exceeds the "unified credit exclusion equivalent" ($1,000,000 in 2002 and scheduled to increase to $3,500,000 by 2009), the excess is subject to tax rates beginning at 37% and climbing to 50%.  For someone with an estate potentially subject to federal estate tax, each $11,000 gift currently may save about $4,000 in estate tax.

Another reason to make lifetime gifts is that shifting income-producing assets from high income taxpayers' brackets to low-income taxpayers can result in the income being taxed at much lower rates, reducing the total income tax burden of the family.

Life insurance can be transferred during lifetime to a trust with very little "cost" in terms of taxes or loss of financial security, and yet save tremendous amounts in federal estate tax and state death taxes.  If life insurance is purchased and owned by an irrevocable trust, the proceeds can be applied for the benefit of your family or other beneficiary after your death, free of any federal or state death taxes.

There are also many non-tax reasons for making gifts in trust.  One of these is to protect your assets from the claims of your creditors.  Suppose your profession makes you a potential subject of a lawsuit for professional errors, or your business operations expose you to financial risks in the event of unexpected market or business changes.  You may want to transfer some of the assets you have accumulated to your spouse or children to make sure that they will be able to enjoy them and benefit from them even if you might not.  By placing an asset and its income in an irrevocable trust beyond your reach, assuming there is no fraud, you are also placing that asset beyond the reach of your creditors.

Please feel free to call to discuss more about trusts and how they may play a role in your family's financial security.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

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