What Is an Irrevocable Trust and When Does It Make Sense?

The word irrevocable tends to make people nervous, and that reaction makes sense. You are giving up control over something, and that is not a decision anyone takes lightly. But understanding what an irrevocable trust actually does, and why someone would choose one, makes the decision much less intimidating.

A revocable trust, which is the kind most people set up as the foundation of their estate plan, can be changed or canceled at any time during your lifetime. You remain in control of the assets inside it. The tradeoff is that because you retain that control, those assets are still considered yours for tax and creditor purposes.

An irrevocable trust works differently. Once assets are transferred into it, you generally cannot take them back or change the terms without the consent of the beneficiaries. That sounds like a loss, but it is also the source of the trust's power.

Because those assets are no longer legally yours, they are generally not included in your taxable estate when you die. For people whose estates may be subject to federal estate tax, removing assets from the estate now can result in significant tax savings for the next generation.

Irrevocable trusts are also used for asset protection. Assets held in a properly structured irrevocable trust may be protected from future creditors, depending on how and when the trust was created. This is particularly relevant for business owners, physicians, and others with exposure to professional liability.

There are many different types of irrevocable trusts, and each one is designed for a specific purpose. Some are designed to remove life insurance from your estate. Others are designed to benefit a spouse while reducing estate taxes. Others are designed to transfer a business interest to the next generation over time.

The common thread is that irrevocable trusts are planning tools for people who want to do more than just pass assets along. They are for people who want to do it strategically.