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In recent years, an increasing number of people have incorporated trusts into their estate planning. Trusts are a popular estate planning tool in part because they avoid the probate process and give the creator of the trust (called the grantor, settlor, or trustmaker) greater control over how and when distributions are made to beneficiaries. There are many types of trusts designed for various purposes, and all of them fall into one of two categories: revocable trusts and irrevocable trusts.
People tend to be more familiar with revocable trusts, also called revocable living trusts or living trusts. In a nutshell, these trusts allow a grantor to create a trust, fund it with assets, and act as both trustee (manager of the trust) and beneficiary of the trust during their lifetime. They can do anything with trust assets that they could have done when the assets were owned in their own name.
A revocable living trust also names “remainder” beneficiaries who will benefit from the trust after the grantor’s death. The term “revocable” means that the trust can be revoked; while they are alive and legally capable, the grantor can choose to end the trust and take back its assets, or can change beneficiaries. When the grantor dies, a revocable living trust becomes irrevocable: it can no longer be changed. The remainder beneficiaries become current beneficiaries, and the successor trustee named in the trust takes over management.
Some trusts are irrevocable from the moment of their creation. Unlike revocable living trusts, the grantor does not retain control over the assets in the trust once the trust is funded. These trusts offer much less flexibility than revocable trusts, but have other benefits that make the loss of flexibility and control worthwhile under certain circumstances.
When you put assets into an irrevocable trust, unlike a revocable trust, you give up “incidents of ownership” in those assets. Giving up incidents of ownership has certain legal implications. Most notably, it reduces the size of your taxable estate, reducing the likelihood that your estate will have to pay tax on those assets.
Now, estate tax is a concern for only a small percentage of the population. In 2022, the federal gift and estate tax lifetime exemption is $12.06 million per person. If you are married and your spouse dies before you, the unused amount of their exemption is “portable” to you. If your only reason for having an irrevocable trust is to avoid estate tax, and your estate is valued at less than the exemption amount, there is no reason to tie up your assets in an irrevocable trust.
That said, the federal exemption amount is currently at a historic high; it is scheduled to drop back down to about $6.2 million at the end of 2025. Therefore, some individuals whose estates might not currently owe tax could find their estates suddenly subject to estate tax in a few years. In that case, it could make sense to reduce the size of one’s taxable estate by putting some assets in an irrevocable trust. Additionally, the Minnesota estate tax exemption is a much lower $3,000,000, and any unused portion is not portable to a surviving spouse.
Another advantage of irrevocable trusts is that they can protect assets against potential future creditors (putting assets in a trust to evade known creditors may constitute fraud). Generally speaking, creditors cannot reach assets that debtors themselves do not have a right to. By placing assets in a properly drafted irrevocable trust, you place them not only out of your own reach, but out of your future creditors’. Doctors and other professionals who have significant income and exposure to malpractice lawsuits often use irrevocable trusts for asset protection.
One more reason that people create irrevocable trusts is to preserve assets for their loved ones who are becoming eligible for government benefits. Specifically, an irrevocable trust may be used to exclude assets from being “countable” for purposes of Medicaid (known as Medical Assistance in Minnesota), should the grantor need extended long-term care. Medicaid will pay for nursing home care so long as an applicant’s countable assets are below $3,000. This requirement causes many people to have to “spend down” their hard-earned assets to qualify for assistance, leaving little behind for family members.
Trusts for each of the above purposes must be carefully drafted to comply with legal requirements. Otherwise, the trust could fail in its intended purpose.
The very thing that makes irrevocable trusts useful for tax planning, asset protection, and Medicaid planning—its permanence—is also the biggest drawback to having an irrevocable trust. If it turns out that your estate doesn’t exceed exemption amounts, or you don’t get sued, or you don’t need Medicaid to pay for nursing home care, you have given up control of your assets for no reason.
Furthermore, you may find yourself in a situation in which you want to change your trust beneficiaries. With an irrevocable trust, that may be difficult or impossible. If you have a falling out with one of your children and decide after the trust’s creation that you want to disinherit them, you’re probably out of luck.
The bottom line is that irrevocable trusts can be useful in the right circumstances, but you should definitely consult with an experienced estate planning attorney to make sure they are the right choice for your needs. If you do need an irrevocable trust in Minnesota, an attorney experienced in drafting these types of trusts can ensure that your trust meets all legal requirements. To learn more, please contact Mundahl Law to schedule a consultation.