An irrevocable trust is a special legal entity that you can use to protect assets that you want to leave to heirs or others. Once you put assets into an irrevocable trust, they generally stay there under the control of a third party that follows the rules that you create when you first set up the trust. The irrevocable nature of the trust conveys two significant benefits. First, assets pass to your heirs estate-tax-free when you die because they are technically no longer yours. Second, because the contents of the trust aren't yours anymore, they generally get protected from being taken in lawsuits or bankruptcies.
Irrevocable Trusts and Taxes
One of the biggest benefits of an irrevocable trust is that when you die, the assets in it pass to your heirs tax-free. The drawback to this is that you have to potentially pay taxes when you put money into the trust. Contributions to your irrevocable trust are subject to being taxed under the IRS' gift and estate tax system. This may limit how much you choose to deposit.
Annual Gift Tax Exemption
The IRS allows you to give a certain amount of money every year to anyone you want, tax-free. For the 2014 tax year, the exemption is $14,000. This means you can put up to that much money in your irrevocable trust without having to pay any gift tax on it. When you die, your heirs receive the money -- and any growth that it enjoys -- tax-free as well.
Lifetime Gift Tax Exemption
Another strategy could be to put even more into your trust tax-free by using some or all of your lifetime estate gift tax exclusion. The IRS allows you, as of 2014, to give up to $5.34 million in gifts or, after you die, bequests free of estate tax. This means you can put additional money into your irrevocable trust and, as long as you stay below your lifetime limit, it'll be a tax-free transfer.
The Bigger Picture
The tax code tells you how much money you can put into your irrevocable trust tax-free, but it doesn't tell you how much you should deposit. That is a much more personal decision. The more money you can put into your trust, the more you will protect from your creditors and the more you will protect for your heirs. On the other hand, money in your trust is also money that you can't touch, control or, potentially, use while you are alive. This is why finding the right balance is a personal decision you may want to make with the help of trusted financial and estate advisers.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.