Though the names might sound simple, revocable and irrevocable trusts can get quite complicated. These terms most often arise during estate planning, and people often utilize these tools to pass property to beneficiaries and lower their estate taxes at the same time. Each type of trust has some unique benefits, but each also has some drawbacks that might make you think twice before establishing one for yourself. Keep reading to learn about the key differences between these types of trusts and when you might need to use them.
Revocable Trust VS. Irrevocable Trust: Key Differences
While there are some big differences between the two, there are also a few similarities. Both of these kinds of trusts are established by the grantor for the benefit of the beneficiaries. Both types of trusts will allow for avoidance of the probate process. This means that the grantor can transfer assets to the beneficiaries upon his death without going through the probate court. Not only does this expedite the transfer of the assets, but it also maintains privacy of the details of the transfer. Probate court proceedings become public record, so the details of the deceased’s will would become public. Trusts are private documents, and they remain that way even after the death of the grantor.
Now, for the differences between irrevocable and revocable trusts. One of the biggest differences can be implied from the names themselves. A revocable trust can be amended or terminated by the grantor at any point during his or her lifetime. However, an irrevocable trust cannot be changed or revoked. The only exception to this rule is when all the beneficiaries of the irrevocable trust agree to the change.
Another big difference between the two is control over the assets. With a revocable trust, the grantor retains control over the assets. Since the grantor has the power to control the “beneficial enjoyment” of the assets, the trustee does not have ultimate control of the assets. If the grantor wishes to take back ownership of the assets, then he has the authority to do so. With an irrevocable trust, however, control of the assets belongs to the trust and trustee. The grantor must relinquish all ownership and control of the assets over to the trust.
Finally, there is also a big difference between the two when it comes to taxes. Revocable trusts are treated as disregarded entities by the IRS. This means that income from the trust is taxed at the grantor’s personal tax rate. The income is treated as taxable income and must be claimed on the grantor’s personal income tax return using his or her Social Security number. By contrast, an irrevocable trust has its own unique tax identification number. The trust itself pays the taxes from the trust assets.
| Revocable VS Irrevocable Trust: Key Differences | ||
| Revocable | Irrevocable | |
| Control Over Assets | Grantor | Trustee |
| Who Pays Income Taxes | Grantor | Trust itself |
| Avoidance of Probate | Yes | Yes |
| Estate Tax Implications | None. Assets are still considered part of the grantor’s estate. | Provides estate tax advantages because assets are no longer considered part of the grantor’s estate. |
| Asset Protection | No | Yes |
Revocable Trusts
Revocable trusts may also be called revocable living trusts or inter vivos trusts. All revocable trusts, by their very definition, must be living trusts. If the grantor has the ability to revoke the trust, then the grantor must be alive. All living trusts become irrevocable upon the death of the grantor. By contrast, all testamentary trusts are irrevocable because the grantor is already deceased. A testamentary trust is created by provisions of the grantor’s last will. Revocable trusts can be powerful estate planning tools that allow for the distribution of assets or property to the beneficiaries of the trust without going through the lengthy and complicated probate process.
In addition, revocable trusts provide the grantor great flexibility to make changes going forward. The grantor retains control of the assets in the trust, therefore can make changes or revoke the trust at any time. Should the grantor become incapacitated, there is no need for appointment of a conservator. The terms of the trust continue to govern the assets, and the successor trustee can continue to act and carry on the affairs of the trust. A durable power of attorney can accomplish this as well, but without one of these documents, a conservatorship would be needed upon the incapacity of the settlor.
For tax purposes, a revocable trust does not provide many tax benefits. The assets of the trust are still treated as part of the settlor’s estate; therefore, they are not excluded from estate taxes. They similarly are not excluded when determining eligibility for Medicaid and other government services.
Irrevocable Trusts
Irrevocable trusts provide many of the same benefits as revocable trusts when it comes to transferring property to beneficiaries. However, an irrevocable trust does not provide the same level of flexibility. Upon creation of the irrevocable trust, the grantor must completely give up control and ownership of the assets placed into the trust. However, this does provide the settlor some additional benefits that do not come along with a revocable trust.
Once assets are placed into an irrevocable trust, they are no longer considered part of your estate. This could save lots of money on estate taxes, and this feature is also often used for Medicaid planning. If you or a loved one might need long term care in a nursing home or other facility, the expense could quickly deplete your assets. However, by moving assets into an irrevocable trust, you might qualify for Medicaid which would pay for these health care expenses. Make sure you start early though! The assets must remain in the trust for a number of years before they are excluded from your asset calculation for Medicaid eligibility.
Choosing Between Revocable And Irrevocable Trusts During Estate Planning
When it comes time to create a trust agreement, you will want to make sure you know which kind of trust is right for you. If you simply want to use a trust to transfer assets outside of probate, then a revocable trust is the best route. This kind of trust will accomplish your goals while still affording you the flexibility to make changes down the road. You will be able to create a fairly simple trust document that will take care of everything you need to do.
However, if you have a large estate and are trying to save the most money on Federal estate taxes, then an irrevocable trust is probably the right choice. An irrevocable trust does not afford you the same flexibility as a revocable trust, but it removes assets from your estate for tax purposes. This type of trust is probably the right choice if you are trying to divest your assets in anticipation of long term care needs as well. Finally, if you are a business owner who needs to shield assets from creditors, then an irrevocable trust is the way to go. This kind of asset protection is not provided by a revocable trust.
In some cases, you might even need both types of trusts! Nothing says that you can only choose one. The details of your estate plan should be determined by your personal finances and close consultation with an estate planning law firm. Your estate planning attorney can help you set up the proper legal entity that meets your needs according to your personal situation.
The Bottom Line
Trusts are extremely useful legal instruments that can provide many great benefits when it comes to estate planning. Choosing between a revocable and irrevocable trust can raise many questions, and you should make sure that you choose the one that is best for you. An experienced estate planning attorney can help you make the best decision. Whether you need flexibility, asset protection, tax benefits, or other advantages, one of these types of trusts might work well for you. Setting up a trust is easy, and you should seriously consider it as part of your estate plan.
Frequently Asked Questions
Is a revocable trust better than an irrevocable trust?
It depends on your needs and goals. If you need flexibility and the ability to maintain control of your assets, then a revocable trust is the better choice. However, if you need tax benefits or asset protection, then you should choose an irrevocable trust. Each one offers unique advantages, so make sure that you select the one that best fits your needs.
Why would you want an irrevocable trust?
There are many reasons that a person would want to establish an irrevocable trust. First, it allows the grantor to transfer property to beneficiaries without going through the probate process. Next, the details of the transfers remain completely private and do not become public record. Irrevocable trusts can provide immense estate tax benefits, and they also provide asset protection. This means that once assets are placed into the trust, creditors cannot gain access to those assets should a lawsuit against the grantor arise. This can be particularly useful for people whose occupation might subject them to a high possibility of litigation like doctors or lawyers.
What are the major disadvantages of revocable living trusts?
The major disadvantages of revocable living trusts are the fact that they do not provide any real tax benefits and they do not provide asset protection. Since the settlor retains control over the assets, those assets are still considered part of the settlor’s estate. The income taxes on any trust income must be paid by the settlor, and creditors can get their hands on those assets should legal action take place.
Do you need a living trust if you have a will?
It depends. Even if you have a will, you might still be able to benefit from a living trust. You may be able to save money on taxes, and you can definitely avoid probate for your beneficiaries with a living trust. In addition, a will cannot protect your assets from creditors while certain types of living trusts can. You should speak with an estate planning attorney to help you decide between a living trust and a will or whether you might need both documents.