Why Knowing The Difference Is Critically Important
There are many different types of trusts, but they all fall into two categories:
One of the most common questions posed during an initial estate planning consultation is, what is the difference between a revocable and irrevocable trust?
Both types of trusts include:
- Grantor – the creator of the trust
- Trustee – the individual or third party who manages the trust and distributes assets
- Beneficiaries – individuals who receive the trust distributions
Both types of trusts avoid probate and allow you to maintain privacy. In addition to saving time and money associated with the probate process, you can protect your family’s documents from becoming part of public record.
What Is A Revocable Trust?
Revocable trusts, commonly referred to as revocable living trusts, can be changed or terminated during the grantor’s lifetime as long as they are competent. The grantor is usually the initial trustee and maintains full control over the assets placed in the trust. A successor trustee is named to manage the trust assets if the grantor becomes incapacitated or passes away.
Upon death, a revocable trust becomes an irrevocable trust and cannot be changed. At this point, the successor trustee must follow the instructions in the trust document to distribute the trust’s assets.
Benefits of a Revocable Trust
- Flexible. This type of trust is attractive because you can update your beneficiaries, change which assets are included in the trust, and update how assets will be distributed.
Disadvantages of a Revocable Trust
- No protection from long term care costs. While you are living, a revocable trust does not protect your assets from long-term care costs like a nursing home. Only an irrevocable trust will protect against expensive long-term care costs.
- Requires funding, or “linking of assets.” Unlike a will that does not require retitling of assets, a revocable trust requires you to link your assets to the trust. This can be a bit of work up front; however, it will save your beneficiaries a great deal of time and expense after you pass. Note however, albeit having a will does not require retitling, a will does NOT avoid probate.
What Is An Irrevocable Trust?
Irrevocable trusts cannot be changed or terminated during the grantor’s lifetime without all the beneficiaries’ permission or approval. The grantor relinquishes control over the trust and the assets placed in the trust.
They can be formed as a living trust, or are converted from revocable trusts upon a grantor’s death. They might also be funded through a pour-over will, which creates a trust upon your death.
Benefits of an Irrevocable Trust
- Asset Protection. An irrevocable trust provides protection from creditors, litigation, and long-term care costs during the lifetime of the person who created it.
- Tax Benefits. The IRS does not consider irrevocable trust assets to be in the grantor’s taxable estate. Therefore, you can avoid or reduce estate, income or gift taxes after your death depending on your circumstances.
- Access to Government Benefits. Assets placed in an irrevocable trust are not counted as an asset for eligibility in Medicaid or other government assistance programs. Therefore, you may not have to deplete your assets before qualifying for assistance, and can preserve your family’s wealth for future generations. Sheltering assets in an irrevocable trust – such as a marital home – may also allow you to maintain their use while not technically owning them.
Disadvantages of an Irrevocable Trust
- Tax Returns. After death the trust is its own entity with its own Tax ID number, therefore irrevocable trusts must file tax returns post death.
- Tax Rates. Any income tax that the trust earns will be taxed separately, and typically at a higher rate.
Key Similarities and Differences Chart: Get Help Understanding Which Is Right For You
| Revocable Trust | Irrevocable Trust | |
|---|---|---|
| Avoids Probate & Public Record | Yes | Yes |
| Can Easily Be Changed | Yes, as long as the grantor is competent | No |
| Can be Terminated | Yes, although if not terminated before death, they become irrevocable | Yes, but not as easily as revocable |
| Subject to Estate Taxes | Yes | No |
| Protects Assets from Creditors & Litigation | No | Yes |
Knowing which is best usually depends on what level of protection you need while trying to accomplish your unique goal.
Consider a revocable living trust if:
- You want to avoid probate court and protect assets for your beneficiaries
- Efficiency and privacy are important to you
- You think your plans for your assets might change over the course of your lifetime
- You think you might like to change your beneficiaries as your family grows or changes
Consider an irrevocable living trust if:
- You are concerned about long-term care costs
- The value of your estate is higher than the federal estate tax exemption and you want to avoid or reduce estate taxes
- You are in a high-profile career and want to protect your assets from creditors and lawsuits
If you’re interested in setting up a revocable or irrevocable trust, consider scheduling a free consultation with an estate planning attorney for guidance.
This blog is for educational purposes only; it is not intended to provide legal advice. If you’re planning for your estate and want to speak with an attorney, call 216-573-3723.
