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How Do Irrevocable Trusts Work?

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Important information on this retirement planning tool.

In the world of retirement planning, consumers can use many different devices to try to protect their assets, accumulate wealth and direct their legacy to their heirs. One of the most popular and straightforward of these is the irrevocable trust.

What is an irrevocable trust?

First, a brief description of what a trust is. A trust is an agreement between two individuals in which one individual grants property (in many different forms) to another, in order for them to hold the assets for a third person - the trust beneficiary. An irrevocable trust is one that can't be changed or adjusted except in the limited circumstances outlined in the trust document. Irrevocable trusts also have independent third-party trustees appointed to them. When you have an irrevocable trust and you name a beneficiary, appoint a trustee and fund it with permissible assets, you may not be able to undo these decisions. The trust document will also spell out specific instructions for releasing funds and assets to the beneficiary.

Benefits of an irrevocable trust.

Assets used to fund an irrevocable trust are no longer owned by you, as they become the property of the trust. With an irrevocable trust, because you can't take the property back or make any changes, you also remove any financial interest you might have once had in the property.

Removing this property from your interests ensures that you no longer have to pay taxes on any growth or realized gains on the property (although the trust likely will have a tax obligation). This can benefit you by lowering your tax liability each year on assets you had already planned to leave to your heirs and didn't need for your own personal use. An irrevocable trust also keeps your assets safe from most creditors. Since you no longer have a financial interest in the assets, they cannot be taken from the trust as part of divorce or other proceedings introduced by creditors.

Finally, an irrevocable trust also removes these assets from your estate so that federal estate taxes are no longer assessed. And since they are already technically the beneficiary's property, they do not need to go through probate court after death, which means your beneficiaries might have access to them much sooner than had the assets simply been willed to your heirs.

Assets for irrevocable trusts.

Trusts can hold many different types of assets. Life insurance policies can be owned by an irrevocable trust (an arrangement referred to as an ILIT); cash, stocks, bonds and business assets can as well. You should note that you will lose control over any asset you use to fund the trust and will no longer have any influence over future investment decisions for the asset. You also will not have access to withdraw any value from it.

Since some assets, when given to the trust, will be considered "sold" to the trust and have a tax consequence as a result, it is best to check with an advisor before deciding how to fund the trust.

Irrevocable trusts offer benefits to both you and your heirs and can make estate planning both efficient and geared toward asset preservation. They can be used to plan estates of any size and are affordable methods of setting up and maintaining your legacy.

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