Can You Break an Irrevocable Trust?

Individuals will frequently set up an Irrevocable Trust and then transfer ownership of various assets, such as brokerage accounts, savings accounts, and real estate, into the trust to protect those assets from the Medicaid spenddown process in the event of a future long-term care need. As a part of the planning process, it is typically recommended that individuals only transfer assets into the trust that they will not need to access in order to meet future expenses. But what happens when someone realizes they have transferred too much into their trust, and they now need access to that asset? The options may be very limited.

Limited Access to Irrevocable Trust Assets

The primary reason that setting up an Irrevocable Trust, also known as a Medicaid Trust, can be an effective way to protect assets from a future long-term care event, is the “grantor” (the person giving the assets to the trust), it essentially giving away the ownership of that asset to their Irrevocable Trust.  By transitioning ownership away from the grantor, if a long-term care event occurs, those assets do not need to be “spent down” for the grantor to qualify for Medicaid for the purpose of paying the costs associated with their long-term care.

In order for this strategy to work, the irrevocable trust has to limit the grantor’s access to the “principal” of the trust assets.  In other words, if, as the grantor, you gift $100,000 into your Irrevocable Trust, you are not allowed to touch that $100,000 for the remainder of your life since you have “irrevocably” gifted those assets to your trust.

Grantors Typically Have Access to Trust Income

While the grantor is unable to access trust principal, most grantors of irrevocable trusts give the grantor access to any “income” generated by their trust. If the trust is holding investments, income refers to only the dividends and interest and does not include the “appreciation” in the trust assets, which is still considered principal.

Example: Sue gifts $200,000 in cash to her irrevocable trust, and then invests that $200,000 in stocks, bonds, CDs, and mutual funds. Over the course of the first year, the value of the trust grew from $200,000 to $220,000; $5,000 of that growth was dividends and interest, and the other $15,000 was the appreciation in the value of the investment holdings. If Sue’s trust document grants her access to the income generated by the trust assets, she would be allowed to withdraw the $5,000 in dividends and interest. However, she would not have access to the $200,000 initial investment or the $15,000 in gains from the appreciation of the underlying investment holdings, only the income from dividends and interest is available to the grantor.

Rules Vary from Trust to Trust

But what if the income is not enough? What if something has happened that now requires Sue, in the example above, to get access to $100,000 of the cash that she contributed to her Irrevocable Trust? The answer lies in the provisions that are built within Sue’s trust document.

This trust document governs what can and cannot be done with assets owned by the trust. Since trust and estate attorneys often take different approaches when drafting trust documents, the options are NOT UNIFORM for all irrevocable trusts. The grantor must work with the attorney drafting the trust to determine what fail-safes, if any, will be built into the trust document. 

Gifting Rights

The trust document can voluntarily allow the trustee, who may or may not be the same person as the grantor, to make gifts from the principal of the trust to the trust’s beneficiaries. The grantor is typically not a beneficiary of the trust.  A common scenario is a parent, or parents, are the grantor(s), fund the trust and select one of their children to serve as trustee (who oversees the trust assets), and then the beneficiaries of the trust are all of the children of the grantor(s).

If the trustee is given gifting powers, the trustee could gift cash directly from the trust to the grantor's children, and then the children could voluntarily turn around and gift cash back to their parents to cover expenses or pay expenses on their parents' behalf.

This is where trust documents vary as well. Some trusts, even with gifting power, do not allow the beneficiaries to make cash gifts back to the grantors, and in those cases, the kids (beneficiaries) have to pay the expenses directly on behalf of their parents (grantor), such as rent, medical expenses, roof, etc., without the parents every coming into contact with the cash that was distributed from the trust to the kids.

Caution: A note of caution when adding gifting powers to a trust. If you give the trustee the power to make gifts from the trust assets, you must 200% trust the person that you have selected to serve as your trustee. As financial planners, we have unfortunately seen a few cases of trustees abusing their gift powers, and it’s not a pretty sight. 

Revoking A Trust

The trust document may also permit a full or partial revocation of the trust assets, resulting in the dissolution of the trust and the return of the trust assets to the grantor. Often, when a trustee seeks to revoke all or a portion of the trust assets, it requires the approval of all the trust beneficiaries. For example, if there are three children, and one of them is money-hungry and does not want to see their inheritance go back to their parents and be spent, they may be able to stop the trust revocation process by simply not agreeing to the revoke the trust assets.

Partial Versus Full Revoke

Some trusts allow a partial revocation of trust assets, while other trust documents only permit a full revocation if approved by the trust’s beneficiaries.  Partial revocation can be an attractive option because it allows some of the trusts principal to be returned to the grantor, but any assets that remain in the irrevocable trust will continue to be protected from future long-term care events, assuming the trust has satisfied the Medicaid lookback period. 

For example, parents fund a trust with $400,000 in cash, and 10 years after the trust is established, an unexpected medical event occurs requiring them to pay $50,000 which they don’t have. If the trust allows a partial revocation of the trust assets, the trustees and beneficiaries could agree to revoke $50,000 of the trust assets, return them to the parents, and the remaining $350,000 stays protected in the irrevocable trust.

However, we have seen trust documents that only allow a full revocation, which then makes it an all-or-nothing decision.

Change Trust Investment Strategy to Generate More Income

We have encountered situations where the trust document does not permit gifts, and it does not allow for partial or full revocation of the trust assets - so what options are left?

From a return of trust principal standpoint, the grantors may be out of luck, however, since most grantor irrevocable trusts give the grantors access to “income” generated by the trust assets, the grantors may be able to work with their trustee to change the investment holdings within the trust to produce more dividends and interest income. For example, if the trust was holding mostly growth stocks that do not pay dividends, the trustee could work with the trust's investment advisor to reallocate the portfolio to stocks and bonds that produce more dividend and interest income, which can then be distributed to the grantors to cover their personal expenses.

Tax Note: When reallocating irrevocable trust accounts, the trustee must be cautious of the taxable realized gains that arise from selling investments in the trust that have significantly appreciated in value. Since most of these Medicaid trusts are set up as “grantor” trusts, even though the grantor does not have access to the principal of the trust, the grantor is typically responsible for paying any tax liability generated by the trust assets.  In other words, if the trust generates a significant tax liability from trade activity, the grantor may be required to pay that tax liability without being able to make a distribution from the trust assets.

Disclosure: I’m a Certified Financial Planner, not a trust and estate attorney. The information in this article was gathered through my firsthand interaction with trusts and our clients. This information is for educational purposes only. For legal advice, please contact an attorney.  

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What happens if I need access to assets that I transferred into an Irrevocable Trust?
Once assets are transferred into an Irrevocable (Medicaid) Trust, the grantor gives up ownership and access to the trust’s principal. In most cases, the only funds the grantor can access are the dividends and interest income generated by the trust. Access to principal is extremely limited and depends entirely on the language in the trust document.

Can the grantor of an Irrevocable Trust access the trust principal?
Typically, no. The primary reason assets inside an Irrevocable Trust are protected from Medicaid spenddown is that the grantor gives up access to the principal. Allowing the grantor to withdraw trust principal would jeopardize the protection of those assets from long-term care costs.

Can I receive income from an Irrevocable Trust?
Yes. Most Irrevocable Trusts permit the grantor to receive income generated by the trust, such as dividends and interest. However, capital gains and appreciation of trust assets are considered principal and remain off-limits to the grantor.

Can my trustee gift trust assets back to me?
Some trust documents include “gifting powers” that allow the trustee to make gifts to the trust’s beneficiaries, often the grantor’s children. Those beneficiaries can then use that money to pay the grantor’s expenses directly (but not give cash back to the grantor). Whether this is allowed depends on how the trust was drafted, so it’s essential to review the trust document.

What if my trust doesn’t allow gifting or revocation?
If neither gifting powers nor revocation clauses exist in the trust, the grantor cannot access the trust principal. However, the trustee may be able to adjust the trust’s investment strategy to generate more income, such as shifting from growth-oriented investments to dividend- and interest-paying assets, which can be distributed to the grantor.

Can an Irrevocable Trust be revoked or dissolved?
Some Irrevocable Trusts allow for full or partial revocation if all beneficiaries agree. A partial revocation allows specific amounts to be returned to the grantor, while the remaining balance stays protected. In other cases, only a full revocation is permitted, which would eliminate the trust’s Medicaid protection entirely.

What are the risks of allowing gifting powers or revocation rights in a trust?
Granting these powers requires a high level of trust in your chosen trustee and beneficiaries. Trustees with gifting authority could misuse or mismanage assets. Similarly, any ability to revoke or withdraw assets could weaken the trust’s Medicaid protection if not handled properly.

What are the tax implications of changing a trust’s investments?
Most Medicaid Irrevocable Trusts are “grantor trusts,” meaning the grantor pays income taxes on any investment activity within the trust. If the trustee sells appreciated investments to reallocate the portfolio, the grantor may owe taxes on the realized gains—even though they cannot withdraw funds from the trust to pay the tax bill.

Why is it important to work with an attorney when setting up or modifying a trust?
Trust provisions vary widely by attorney and state. Small drafting differences can determine whether the grantor can access income, allow partial revocation, or protect assets from Medicaid. Always consult a qualified trust and estate attorney before making or relying on any changes.