While you may assume that trusts are only for the extremely wealthy, many types of estates may benefit from either a revocable or irrevocable trust.
In addition to avoiding the necessity of having assets pass through probate, creating an irrevocable trust may help minimize the tax burden on your estate both during your life and after your death.
How do irrevocable trusts differ from revocable trusts?
Under a revocable trust, you maintain control of assets in the trust during your lifetime. However, you are also responsible for paying taxes on income from the trust.
Under an irrevocable trust, you no longer legally own assets transferred to the trust and cannot access those assets except through your trustee. However, by separating those assets from your personal estate, you may be able to reduce your annual tax liability.
What are the tax implications of an irrevocable trust?
An irrevocable trust is a separate tax entity. Under a simple irrevocable trust, assets earn income or interest that is payable to beneficiaries and taxable according to the income tax rates of those beneficiaries.
Under a complex irrevocable trust, the trust may either retain or distribute earned income. If retained, the trust pays tax on that income based on trust income tax rates.
In either case, this estate scheme may help reduce your taxable estate, shift income tax burdens to lower brackets and minimize or eliminate estate taxation after your death.
What are the potential downsides of an irrevocable trust?
Establishing an irrevocable trust requires permanently relinquishing control of assets. While this may create a tax advantage, it may also result in an inflexible scheme that could present problems if your financial circumstances change.
Before creating a trust, make sure you fully understand the implications for both your tax burden and your future income needs.