Though the names might sound simple, revocable and irrevocable trusts can get complicated.
These terms often arise during estate planning, and people frequently use these tools to pass property to beneficiaries and simultaneously lower their estate taxes.
Each type of trust has unique benefits, but some drawbacks might make you reconsider establishing one for yourself.
Please keep reading to learn about the key differences between these types of trusts and when to use them.
Revocable Trust vs Irrevocable Trust: Key Differences
While the two have some significant differences, there are also a few similarities.
- The grantor establishes both of these kinds of trusts to benefit the beneficiaries.
- Both types of trusts will allow for avoidance of the probate process.
This means the grantor can transfer assets to the beneficiaries upon death without going through the probate court. This expedites the transfer of the assets and maintains the privacy of the details of the transfer.
- Trusts are private documents that remain that way even after the grantor’s death.
Probate court proceedings become public records, so the details of the deceased’s will would become public.
Now, for the differences between irrevocable and revocable trusts.
- One of the most significant 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 them. If the grantor wishes to take back ownership of the assets, he has the authority to do so.
However, with an irrevocable trust, the trust and trustee have control of the assets. The grantor must relinquish all ownership and control of the assets to the trust.
- There is also a big difference between the two regarding taxes.
Revocable trusts are treated as disregarded entities by the IRS. This means that income from the trust is taxed at the grantor’s tax rate. The income is taxable 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 a unique tax identification number. The trust itself pays the taxes from the trust assets.
| Trust Features | Revocable | Irrevocable |
|---|---|---|
|
Control Over Assets
|
Grantor
|
Trustee
|
|
Who Pays Income Taxes
|
Grantor
|
The Trust
|
|
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 part of the grantor’s estate.
|
|
Asset Protection
|
No |
Yes
|
KEY TAKEAWAYS
- One of the most significant differences between Revocable and Irrevocable Trusts is the ability or inability to change, amend, or cancel the trust during the grantor’s lifetime.
- Large estates might prefer an irrevocable trust to save money on Federal estate taxes.
- A grantor seeking to retain control of the trust assets and avoid probate upon their death may prefer creating a revocable trust.
Revocable Trusts
Revocable trusts may also be called revocable living trusts or inter vivos trusts. By their very definition, all revocable trusts must be living trusts.
- If the grantor can revoke the trust, then the grantor must be alive. All living trusts become irrevocable upon the death of the grantor.
Contrastingly, 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. They allow the distribution of assets or property to the trust’s beneficiaries without going through the lengthy and complicated probate process.
- Revocable trusts provide the grantor great flexibility to make changes in the future. The grantor retains control of the assets in the trust and, therefore, can make changes or revoke the trust at any time.
Should the grantor become incapacitated, there is no need to appoint a conservator. The terms of the trust continue to govern the assets, and the successor trustee can continue to act and carry on the trust’s affairs.
A durable power of attorney can also accomplish this, but without one of these documents, a conservatorship would be needed upon the settlor’s incapacity.
- For tax purposes, a revocable trust does not provide many tax benefits. The trust assets are still treated as part of the settlor’s estate; therefore, they are not excluded from estate taxes.
Trust assets are not excluded when determining eligibility for Medicaid and other government services.
Must read articles related to Trusts
- Overview of “What is a trust?“.
- Deep dive into understanding irrevocable trusts.
- Discover what inheritance tax is.
- How does a charitable remainder trust work?
- Learn about the differences between a living trust and a will.
Irrevocable Trusts
Irrevocable trusts provide many of the same benefits as revocable trusts when transferring property to beneficiaries.
- An irrevocable trust does not provide the same flexibility as a revocable trust.
Upon creating the irrevocable trust, the grantor must completely give up control and ownership of the assets placed in the trust. However, this does provide the settlor with 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 needs long-term care in a nursing home or other facility, the expense could quickly deplete your assets.
- By moving assets into an irrevocable trust, you might qualify for Medicaid, which could pay for long-term healthcare expenses.
Make sure you start early, though! The assets must remain in the trust for several years before they are excluded from your asset calculation for Medicaid eligibility.
TIP
You may find it beneficial to create a will, a revocable trust, and an irrevocable trust. All three can form a robust estate planning strategy.
Choosing Between Revocable And Irrevocable Trusts During Estate Planning
When it comes time to create a trust agreement, you should make sure you know which kind of trust is right for you.
- A revocable trust is the best option if you simply want to transfer assets outside of probate.
This kind of trust will accomplish your goals while still allowing you the flexibility to make changes. You can create a reasonably simple trust document that will take care of everything you need to do.
- 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.
- An irrevocable trust is probably the right choice if you are also trying to divest your assets in anticipation of long-term care needs.
- If you are a business owner who needs to shield assets from creditors, an irrevocable trust is the solution. This kind of asset protection is not provided by a revocable trust.
In some cases, you might even need both types of trusts. Nothing prevents you from creating two kinds of trusts.
Your finances and close consultation with an estate planning law firm should determine the details of your estate plan. Your estate planning attorney can help you set up the proper legal entity that meets your needs according to your situation.
The Bottom Line
Trusts are beneficial legal instruments that can provide many great benefits regarding estate planning.
Choosing between a revocable and irrevocable trust can raise many questions, and you should make sure 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; you should consider one of the different trust options when developing your estate plan.
Frequently Asked Questions
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, choose an irrevocable trust if you need tax benefits or asset protection.
Each one offers unique advantages, so make sure that you select the one that best fits your needs.
There are many reasons that a person would want to establish an irrevocable trust.
- The grantor can transfer property to beneficiaries without going through the probate process.
- The details of the transfers remain entirely private and do not become public records.
- Irrevocable trusts can provide immense estate tax benefits,
- They also offer 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.
The major disadvantages of revocable living trusts are that they do not provide real tax benefits and 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 settlor must pay the income taxes on any trust income, and creditors can seize those assets should legal action be taken.
It depends on your specific financial situation. Even if you already have a will, you may still be able to benefit from creating a living trust.
There are some significant differences between a living trust and a will. If you prefer to maintain privacy for your estate or want your beneficiaries to avoid the probate process, then a living trust can help you accomplish those goals.
When choosing a living trust vs a will, you do not have to pick just one. People often have a living trust and a will as part of their overall estate plan.
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