Read on for everything you need to know about revocable vs. irrevocable trusts, including what they are and how they differ.
Trusts are estate planning tools that can be used for several purposes, such as managing assets for minor children, providing for a disabled family member, or avoiding probate and estate taxes upon the trustor's death.
One of the key decisions in setting up a trust is whether to create a revocable or irrevocable trust.
This article will explain the differences between revocable and irrevocable trusts and help you understand how to evaluate which type of trust is best for you.
A trust is a legal arrangement in which one party, known as the trustor or grantor, transfers assets to a separate legal entity, the trust. The trustor also appoints a trustee to manage the trust's assets for the benefit of a third party, known as the beneficiary.
Trusts are some of the most commonly used estate planning tools, along with a last will and testament. Unlike a will, though, trusts actually remove assets from your estate. So instead of going through the probate process, trust assets are administered by the trustee based on the terms of the trust, whatever those may be.
The purpose of a trust is to manage and protect assets for the benefit of the named beneficiaries. Trusts can be used for a variety of purposes, such as:
The main parties involved in a trust include:
The two main types of trusts are revocable trusts and irrevocable trusts.
A revocable trust, also known as a living trust or revocable living trust, is a trust that can be amended or revoked by the trustor at any time. The trustor retains control over the assets placed in the trust and can make changes to the trust as their circumstances change.
One of the primary benefits of revocable trusts is that they keep assets out of probate. The probate process can be expensive and time-consuming. A revocable trust can help avoid it by allowing the trust assets to pass directly to the trust's beneficiaries without the need for court supervision.
Another key benefit is the ability to amend the terms of the trust, such as adding or removing beneficiaries. For example, perhaps you created a trust before the birth of grandchildren and now want to specifically account for them in your plans to transfer assets. Revocable trusts allow the flexibility to make such changes based on changed circumstances.
To alter or revoke a revocable trust, the trustor must follow the procedures outlined in the trust document and may need to obtain the consent of the trustee and any other relevant parties. It's important to seek legal advice when making changes to a revocable trust to ensure that the process is handled correctly.
Additionally, another critical benefit of a revocable trust relative to a will is that a revocable trust is effective as soon as the document is signed and the trust is funded. So while a will only kicks in upon a person's death, a revocable trust would be operative if a person became incapacitated but has not passed.
It's important to note that revocable trusts do not offer the same level of asset protection as irrevocable trusts. Since the trustor retains the ability to alter or revoke the trust, the trustor is still considered the owner of the trust assets. These assets, therefore, may still be subject to creditors' claims or lawsuits.
Relatedly, revocable trusts generally do not give the same tax benefits as an irrevocable trust due to the grantor's continued ownership of the assets.
Additionally, while a revocable trust gives the trustor greater flexibility, it can be expensive to revise and update the terms of the trust.
An irrevocable trust is a trust that cannot be amended or revoked by the trustor once it has been established, except in very limited circumstances.
This means that the trustor gives up control over the assets placed in the trust and cannot make any changes to the trust without the consent of all of the trust's beneficiaries. The transferred assets become the trust's assets and are no longer the trustor's own assets.
Many of the benefits noted above about revocable trusts also apply to irrevocable trusts. For instance, irrevocable trusts also keep assets out of probate and take legal effect as soon as they are created (instead of upon the grantor's death).
Separate from these benefits, though, one of the main advantages of an irrevocable trust is that it offers a higher level of asset protection than a revocable trust. Since the trustor cannot alter or revoke the trust, the assets in the trust are generally protected from creditors' claims and lawsuits.
Irrevocable trusts can also be used to minimize taxes, such as estate taxes or gift taxes. For example, transferring assets to an irrevocable trust may allow the trustor to remove those assets from their estate for tax purposes.
Irrevocable trusts are more complicated and expensive to set up and manage than revocable trusts. And remember, once an irrevocable trust has been established, it cannot be altered or revoked, even by the trustor.
It is therefore crucial to seek the advice of a qualified estate planning attorney when establishing an irrevocable trust because getting things right is critical.
If you’re wondering, "how do I decide on an irrevocable vs revocable trust when estate planning," you’re not alone.
Deciding between a revocable and irrevocable trust can be a complex decision, as each type of trust has its own benefits and drawbacks.
Ultimately, which type of trust is better for you will depend on your specific goals and circumstances.
If you want to retain control over the assets in your trust and have the flexibility to make changes to the trust as needed, a revocable trust may be the better option.
And like other trusts, revocable trusts help:
On the other hand, if you are looking for greater asset protection and the possibility of tax savings, an irrevocable trust may be the better choice.
One of the key differences between the two types of trusts is that irrevocable trusts offer a higher level of asset protection and can provide gift tax savings and reduce your taxable estate. So if you are mindful of an impending estate tax or concerned about creditors, an irrevocable trust may be the better option.
They are also typically more expensive to set up, but irrevocable trusts may be the better option depending on the outcome you are trying to accomplish.
Though the names sound similar, living wills and living trusts are very different and address different estate planning needs.
A living will outlines your wishes for end-of-life health care in the event that you cannot make those decisions for yourself. It usually covers situations where you are incapacitated or otherwise unable to communicate your wishes to your medical team. (In this sense, a living will is also a totally different estate planning tool from a last will and testament).
By contrast, a living trust is another name for a revocable trust, which is a trust that can be amended by the grantor.
An irrevocable life insurance trust is a type of trust that is specifically designed to hold a life insurance policy.
The main purpose of an irrevocable life insurance trust is to remove the life insurance policy from the insured person's taxable estate, which can have several benefits for estate planning purposes.
When a life insurance policy is held in an irrevocable life insurance trust, the policy proceeds are paid to the trust upon the death of the insured person. These proceeds are not considered part of the insured person's taxable estate, which helps minimize estate taxes.