Parents and other family members who want to pass on assets during their lifetimes may be tempted to gift the assets. Although setting up an irrevocable trust lacks the simplicity of giving a gift, it may be a better way to preserve assets for the future.
A trust is a legal entity under which one person -- the "trustee" -- holds legal title to property for the benefit of others -- the "beneficiaries." The trustee must follow the rules provided in the trust instrument. An "irrevocable" trust cannot be changed after it has been created. In most cases, this type of trust is drafted so that the income is payable to you (the person establishing the trust, called the "grantor") for life, and the principal cannot be applied to benefit you or your spouse. At your death the principal is paid to your heirs. This way, the funds in the trust are protected and you can use the income for your living expenses.
While gifting assets outright is much simpler process than setting up a trust, the following are some of the advantages of setting up a trust instead:
- Income. Putting assets in a trust means you can receive income from the assets to continue to pay for living expenses. Depending on how the trust is set up, you can receive regular income payments or the trustee could have discretion to make payments.
- Control. With an irrevocable trust, you as the grantor can maintain some control over the assets. You get to choose the trustees and establish the rules of the trust. You can also retain the right to change beneficiaries with a power of appointment in your will.
- Asset protection from creditors. If you give money to a family member directly, that money could be lost to the recipient’s carelessness, creditors, or divorce. Keeping the funds in a trust protects the assets for the future.
- Taxes. If the trust is structured properly, it can have a tax advantage for your beneficiaries. Assets that have gone up in value will receive a “step-up” in basis on your death, which means your beneficiaries will pay less in capital gains taxes. Assets that are gifted do not receive a “step-up.”
- Medicaid. If you anticipate needing long-term care benefits in the future, then it is important to plan ahead. If you give away money or fund an irrevocable trust within the five years (the "look-back period") before applying for Medicaid, you may face a period of ineligibility for Medicaid benefits. The actual period of ineligibility will depend on the amount gifted or transferred to the trust. Putting assets in a trust allows you to plan ahead while retaining some income and control over the assets.