What Are the Different Types of Irrevocable Trusts?

Trusts are highly effective financial tools used in estate planning, asset protection, tax optimisation, and more. There are numerous types of trusts, each with their own unique structure and terms. This makes them highly versatile instruments which can be used in a range of circumstances. 

A primary distinction is made between irrevocable and revocable trusts. In this article, we will briefly outline what an irrevocable trust is and its main benefits. We will then look at some of the most commonly used types of irrevocable trusts. 

Trusts are highly effective financial tools used in estate planning, asset protection, tax optimisation, and more. There are numerous types of trusts, each with their own unique structure and terms. This makes them highly versatile instruments which can be used in a range of circumstances. 

A primary distinction is made between irrevocable and revocable trusts. In this article, we will briefly outline what an irrevocable trust is and its main benefits. We will then look at some of the most commonly used types of irrevocable trusts.  

Table of Contents:

• What Is an Irrevocable Trust?
• The Benefits and Uses of an Irrevocable Trust
• 1. Asset Protection
• 2. Estate Planning
• 3. Tax Optimisation
• 4.To Control Asset Distribution
• 6 Different Types of Irrevocable Trusts
• Choosing the Right Trust 

What Is an Irrevocable Trust?

The simplest definition of an irrevocable trust is that it is a type of trust where the terms cannot be modified or terminated after its inception, except in rare cases and with the express permission of the beneficiaries. 

Irrevocable trusts consist of three parties:

1. the grantor/settlor
2. the trustee, and
3. the beneficiary/ies.

The grantor is the one who initiates the trust, and transfers ownership of assets into the trust. Once the assets have been transferred, the grantor loses all legal rights of ownership.

In turn, the grantor must designate a trustee who is responsible for managing and safeguarding the assets in the trust for the ultimate benefit of the named beneficiary. The beneficiary of the trust is the one who stands to benefit from the assets in the trust and the income which they produce.

There can be more than one beneficiary. The assets in the trust will ultimately be distributed to the beneficiary/ies as per the specific trust terms. In most cases, the three parties which make up an irrevocable trust agreement are distinct from one another.

However, there are special types of irrevocable trusts, such as an Asset Protection Trust (APT), which allow the grantor to simultaneously be the sole beneficiary. These trusts are used as tools to separate legal ownership of assets, whilst personally retaining their benefits. 

The Benefits and Uses of an Irrevocable Trust

Irrevocable trusts have many benefits and uses. These include:

1. Asset protection

Irrevocable trusts are a sound way to legally separate ownership which protects your personal assets. This places them out of reach of lawsuits, creditors, and other threats to your personal estate. 

2. Estate planning

Trusts are popular estate planning tools. They generally allow for smoother transfer of your estate to your heirs, as they avoid drawn-out and costly probate procedures. They can also help reduce estate and gift taxes.

3. Tax optimisation

Irrevocable trusts can be used as part of a tax planning strategy to reduce personal income and capital gains taxes. This is not entirely possible for every person nor situation. It will depend on the type of ass

4.To Control Asset Distribution

Irrevocable trusts come in all different shapes and sizes. They can allow the grantor to create a tailor-made solution for how they want their assets to be distributed to their beneficiaries after death.

For example, spendthrift trusts can be used to control when and how assets are distributed to beneficiaries, as opposed to them receiving the entire estate in one lump sum. 

For more see: Disadvatages of Irrevocable Trusts

6 Different Types

There are over a dozen types of irrevocable trusts, so here we will only outline six of the most commonly used. 

• 1. Asset Protection Trust (APT)
• 2. Irrevocable Life Insurance Trust (ILIT)
• 3. Intentionally Defective Grantor Trust (IDGT)
• 4. Charitable Remainder Trust (CRT)
• 5. Qualified Personal Residence Trust (QPRT)
• 6. Grantor Retained Annuity Trust (GRAT)

1. Asset Protection Trust (APT)

APTs are a special type of self-settled spendthrift trust which allow the grantor to simultaneously be the sole beneficiary of the trust. This makes them an ideal financial vehicle for asset protection and privacy.

Usually, the grantor can structure the terms of the trust so that they retain use and benefit of the assets, without being the legal owner. They will also retain significant control over the assets, as they will be able to direct the way the trustee manages and distributes the assets under normal circumstances. 

It is only if there is a direct threat to the assets held by the trust, due to a legal case against the grantor for example, that the trustee can step in and exercise their responsibility to protect the trust assets. If the grantor is directed by the court to withdraw assets which are held in an APT in order to settle a personal liability, the trustee can refuse to hand over the assets, under the assumption that the grantor is acting under duress.

Offshore APTs in jurisdictions such as Nevis and Cook Islands have historically been especially effective in protecting assets from domestic court rulings and other threats. They also provide financial privacy and tax efficiency.  

2. Irrevocable Life Insurance Trust (ILIT)

This type of trust is specifically designed to own one or more life insurance policies, which are transferred to the trust by the grantor. The transfer of the policy/ies to the ILIT is irreversible, and the trustee manages the final distribution of the insurance proceeds to the beneficiaries after the grantor’s death. 

3. Intentionally Defective Grantor Trust (IDGT)

IDGTs are a unique type of grantor trust. A grantor trust is one where the tax liabilities of the trust are passed directly to the grantor’s personal tax burden. In other words, they are viewed as part of the grantor’s personal estate for tax purposes. IDGTs differ somewhat in that, while the grantor is personally responsible for the tax on income generated by the trust, the assets in the trust are viewed as separate to the grantor’s personal estate for estate tax purposes. 

IDGTs are primarily used to minimise estate taxes by removing them from the grantor’s personal estate, whilst retaining the potential benefits of having the income taxed at the personal level. They are estate planning tools which are created to benefit the grantor’s heirs. 

4. Charitable Remainder Trust (CRT)

A CRT is a highly effective tax savings vehicle which allows the grantor of the trust to simultaneously distribute the trust’s income to beneficiaries, and donate the remainder to a charitable organisation. Usually, CRTs will distribute income earned from the trust assets to the grantor themselves (if they are named beneficiary) or to other beneficiaries for a set period of time. This may be for their lifetime or a fixed number of years. After this period is over, the assets which remain in the trust are kept by the designated charity. This is a good way to provide a charitable donation as well as reduce taxes, as assets donated to the trust enjoy tax exemptions. 

5. Qualified Personal Residence Trust (QPRT)

A QPRT is a type of irrevocable trust used to remove primary residential property from the grantor’s personal estate. The grantor transfers ownership of their personal residence to the trust, with terms which stipulate that they retain the right to live in the residence rent-free for a fixed number of years or until death. 

QPRTs are used as a way to reduce the grantor’s taxable estate, and make it easier to pass on personal residence to their heirs after death. 

6. Grantor Retained Annuity Trust (GRAT)

A GRAT is a type of irrevocable trust whereby the grantor transfers ownership of assets to the trust, and thereafter receives fixed income payments from the trust for a defined number of years while they are alive. After the term is complete, or upon death, the remaining assets in the trust are passed on to the trust beneficiaries. 

GRATs perform a variety of valuable functions. They act as asset protection tools by separating legal ownership of the assets in the trust from the grantor. They allow the grantor to efficiently pass on a portion of their estate to their heirs, whilst retaining the necessary benefits while they are still alive. They are also one of the most tax efficient ways to distribute your estate. 

Choosing the Right Trust 

There is no one-size-fits-all solution when it comes to trust and estate planning. Choosing the right type of trust for you will depend greatly on your specific set of circumstances, the laws in the jurisdiction where you live, and the objectives you wish to achieve. The good thing is that whatever your financial objectives are, there is likely a type of trust which can be tailor-made to help you achieve these objectives. 

Due to the sheer number of trust types available, and their complexity, it is definitely worth enlisting the services of a trust expert to help you determine which type of trust is best suited to your specific needs.