Can You Transfer Assets Out Of An Irrevocable Trust?

An irrevocable trust is one of the best ways to transfer wealth to the next generation without having to suffer through excessive taxes or ensure that the assets are squandered. It provides a surefire way of keeping wealth safe and secure until it’s ready. However, if the situation changes, people may wonder if they can transfer assets out of an irrevocable trust. 

Strictly speaking, you can’t transfer assets out of an irrevocable trust unless you make certain rules about the trust’s contents when it is drafted. We’ll explain more about this later in the article. 

But first, let’s talk about a few basics. 

What is an Irrevocable Trust?

In a nutshell, an irrevocable trust is a trust type where the terms can’t be amended, modified or terminated without getting the permission of the grantor’s named beneficiary(s). The grantor essentially transfers all the ownership of the associated assets into the trust and removes the right of ownership of those assets to the trust itself.

It’s most often used as a securer alternative to a will by providing a rule on how your property and other belongings are distributed to your named heirs.

Upon opening the trust, you designate a trustee and beneficiary. The trustee is the person overseeing or managing the trust, and may or may not be one of the beneficiaries or heirs. Beneficiaries can be whoever you like, but most often it’s friends or family who you believe should get your assets or wealth after your death. 

An irrevocable trust gains its own tax number, the assets within are considered independent until being claimed by the beneficiary. Trustees are responsible for paying taxes owed by the trust, although they can use trust funds rather than their own income to do this.

Speaking of claiming, you can set the rules or regulations that affect the irrevocable trust when you draft it. For instance, you can determine who gets what’s in the trust, when they receive it, and if there are any other conditions that may be required before a beneficiary can take the assets allocated to them. 

Many grandparents will create caveats for the trust, designating that the funds within are specifically to be used for certain types of expenses. This may be the case where beneficiaries don’t demonstrate good monetary judgment.

Irrevocable Trust Disadvantages

There are some disadvantages to making an irrevocable trust in the first place. For instance, older people who transfer the majority of their assets to an irrevocable trust but then later fall into financial hardship cannot remove those assets from the trust. They’d have to talk to their beneficiaries (like their children or grandchildren) and get their permission to remove those assets from the trust beforehand.

This risk is nonexistent if you trust your heirs, of course. But many people act strangely when it comes to money or inheritance and they make decisions that they otherwise wouldn’t.

Basically, consider any assets that you transfer into an irrevocable trust as no longer your own unless you explicitly get the permission of your beneficiaries to make changes or remove the assets.

Irrevocable Trust Advantages

These types of trusts also come with advantages. For starters, they can help you overcome income requirements for health insurance like Medicaid and offer some tax benefits. Remember, assets or wealth that are placed into an irrevocable trust are legally no longer tied to your name. So they no longer count for tax liabilities or toward the value of your remaining estate.

In general, most people who will take advantage of these benefits are those with large estates and lots of wealth tied up in their property or other assets. As a result, high net worth individuals use irrevocable trusts more than regular folks.

How Can You Transfer Assets From an Irrevocable Trust?

In the strictest sense of the phrase, you can’t transfer assets from an irrevocable trust that you created for your future beneficiaries. But do you remember how we described that you could make certain rules or caveats about the trust’s contents as you draft it? You can use those rules to create loopholes in the irrevocability of the trust.

For instance, you can create a rule inviting someone else to amend the trust if something changes between the trust’s creation and the projected date of asset withdrawal. As an example, if a parent created an irrevocable trust for a child with disabilities, they could structure in such a way that the kid would lose eligibility for any government benefits based on the trust’s contents.

Yet they can also include a provision that allows the trustee to amend the trust if laws change and allow the kid to have both the assets and government assistance at the same time.

Another example would be allowing trust assets to be transferred to a separate beneficiary or to a charity or another organization if the original beneficiary does not fulfill the right requirements. Let’s say that an irrevocable trust was created by a set of grandparents for their favorite child. But that kid later did something that they didn’t agree with after they were dead.

Because of the irrevocable trust provision they can either transfer the trust asset to another beneficiary or donate it to a charity.

However, you can’t transfer assets from an irrevocable trust back to your original estate under any circumstances. The only possible loophole of this would be transferring assets to a beneficiary while you were still alive, then having them give you the assets anyway. Still, this would involve lots of taxing on both parties’ part, so what’s the point?

The Power of Appointment

Anyone who creates an irrevocable trust also has the power of appointment. This grants them the ability to determine how the trust assets will be ultimately distributed. It’s another version of one of the above scenarios, where assets can be distributed in a different way from what was originally specified if conditions change.

Let’s say that a mother and father create an irrevocable trust for their son, only for him and his wife to begin the divorce process. By reserving the power of appointment in the irrevocable trust provisions, the parents can then change the asset distribution so that their son’s soon-to-be ex-wife doesn’t get any of the assets after they die.

What If You’re the Beneficiary?

The only other loophole concerning transferring assets out of an irrevocable trust occurs if you are one of the beneficiaries of the trust you create. That’s right; you can make an irrevocable trust specifically designating yourself as the sole or one of the beneficiaries. Why would you do this?

Let’s say that you currently have plenty of wealth squared away, but you’re concerned about your costs of living once you get older and want to ensure that you have enough money around for your twilight years. You can create an irrevocable trust in order to keep this wealth protected until a designated date, condition, or any other factor you choose.

This also prevents you from paying taxes on all of that money or property until you take it out to be used. Technically speaking, this would result in you transferring assets out of an irrevocable trust to yourself. But you can’t also be the trustee, so you’ll need someone else to play this part in order to make this scheme work.

Is it Possible to Terminate an Irrevocable Trust?

Beneficiaries cannot terminate an irrevocable trust under most circumstances. However, a trustee or a qualified beneficiary can terminate such a trust if:

  • the trust purposes have either been fulfilled or have become impractical, illegal, impossible or wasteful to fulfill
  • complying with the conditions of the trust would impair the accomplishment of the material purpose of the trust
  • the material purpose of the trust doesn’t exist

Let’s simplify the legalese. You can terminate an irrevocable trust if the point of the trust would be defeated or diminished by awarding the assets as the contract states. Let’s say, for instance, that grandparents made an irrevocable trust for their grandchildren, but those grandchildren, unfortunately, died before the grandparents. In this case, because the purpose of the trust would be impossible to fulfill, the irrevocable trust could be terminated.

Another good example would be an irrevocable trust containing physical assets like a house. But if the house was a proven danger to a neighborhood and legally needed to be taken down or demolished, the irrevocable trust could be terminated since one of the assets in the trust was demonstrably wasteful.

However, you should note that the original grantor of the irrevocable trust cannot terminate the trust under any circumstances. Even in the original example with the grandparents and grandkids, the petition to terminate the trust would have to be brought forward by the trustee. If you’ll recall, the trustee is an individual other than the original grantor(s).

Conclusion

An irrevocable trust is a very tight contract, and it’s hard to transfer assets out of it by design. However, you can sometimes alter the trust if things change unexpectedly so your efforts aren’t in vain. Let us know if you have other questions about these trusts or if you’ve had experience with them in the past.

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