Differences Between Revocable and Irrevocable Trust: Things You Should Know

On the topic of estate planning, a lot of people are familiar with the term “trust”. You may have even heard mention of terms like “revocable trusts” and “irrevocable trusts.” During estate planning discussions with possible clients, we find that these terms are often used because these clients know people who have trusts. 

There’s also the possibility that their parents had a trust and spoke about it with them. Or, sometimes an aunt, uncle, grandparent, or family friend uses the trust as part of their estate planning. 

However, when discussing trusts, we found that most of our clients do not really understand what they are or how they can be a useful part of their estate planning.

Trust Basics

In case you need a refresher, a “trust” is a legal financial vehicle that a person (the grantor) can set up to manage his or her assets. You would set up a trust during your lifetime to make sure that the assets are used in the way that you desire. Once you, as the grantor, place your assets (or some portion) into the trust, a third party designated by you – called the trustee – manages the assets. 

Trusts can be used as a way to pass on your assets to beneficiaries after you pass away. The benefit of a trust over a last will and testament is that you can avoid considerable tax burdens, and the assets in the trust can go directly to your beneficiaries upon your death, avoiding the long, arduous probate process altogether. 

Now, with regard to trusts, there are two main types – revocable (also called “living trusts”) and irrevocable. Let’s talk about revocable trusts first.

A Revocable Trust – Terms Can Change

The benefit of a revocable trust is that the terms of the trust – i.e., the instructions you place on the management of the trust at creation – can change at any time. With a revocable trust, you can change beneficiaries, add new beneficiaries, and alter the instructions on how the assets in the trust are managed.

Now, having such flexibility with a trust sounds great, right? Well, as with most things, there is a catch. A revocable trust has a few disadvantages compared to an irrevocable one. 

1. No creditor shield - given that the grantor retains control over the trust assets, which means that creditors can access the trust funds to settle debts.

2. Taxes - assets held in a revocable trust are also subject to state and federal taxes when the grantor/creator of the trust dies.

An Irrevocable Trust – Usually Set in Stone

As the name suggests, and in contrast to revocable trusts, an irrevocable trust cannot be changed after it is created. Also, unlike a revocable trust, the grantor/creator of the trust loses all rights to ownership and, essentially, all control of the assets in the trust. Only in rare circumstances can a grantor make changes to an irrevocable trust.

Why would you want such a strict trust, in which you basically lose control over the assets? The answer is easy – taxes.

The assets in an irrevocable trust are removed from the grantor’s estate. Thus, those assets are no longer subject to taxes upon the grantor’s death.

Overall, either an irrevocable or revocable trust are challenging to create. You need a qualified estate planning attorney to assist you.

A Revocable Trust Can Help You Plan for Contingencies

Many people use a revocable trust to set up plans for contingencies. An example of such a contingency plan would be what to do if you become incapacitated. 

A trust allows for seamless handling of the assets of the trust, without the necessity of court intervention to determine who will make decisions. This saves time and money. It also protects your privacy and significantly reduces the potential for family squabbles about who is best able to make the decisions about the trust itself.

An Irrevocable Trust Can Ensure Support of a Loved One

If you have a child who is disabled, an irrevocable trust can provide support. Money is immediately transferred to the trust, and cannot be transferred back to the trustor. A trustee makes determinations about how to handle money to further the goals of the trust, which in this case, would be for the ongoing care of your disabled child.

Using an Irrevocable Trust Can Help You Avoid Capital Gains Taxes

Many people don’t realize this, but there are ways that you can transfer assets into an irrevocable trust so that capital gains taxes can be avoided. 

This alone is not a good reason to transfer funds into an irrevocable trust, however. Many people will never face capital gains taxes, and depending on the circumstances, a gift tax may still be due. 

An estate planning attorney can help you decide whether transferring assets into an irrevocable trust is a smart financial decision in these types of situations.

Why choose an irrevocable trust?

Here are the key reasons why an irrevocable trust may be more beneficial than a revocable trust:

Property Ownership 

The next difference between irrevocable and revocable trusts concerns who owns the trust property. For an irrevocable trust, the trust property such as land, bank account, vehicle or any other type of assets or property is actually transferred to the trust, and the trust becomes the owner of the property. 

 As such, the individuals who previously owned these assets no longer have any ownership rights, and even have no control over properties outside the trust. Again, this is because for an irrevocable trust, once it is created and funded, the trustee or the individual who created the trust cannot change it.

When it comes to revocable trusts, this is not the case. Although technically speaking, once these types of assets and properties are transferred to the trust, the trust becomes its owner, but since the trust is revocable, the ownership can be changed again at any time. 

Therefore, the law holds that the person who created the revocable trust continues to own or at least control the assets, including the power to revoke the trust.

Asset Protection

And this brings us to the third big difference between these two trusts. In terms of asset protection, irrevocable trusts are far better than revocable trusts. Again, the reason for this is that if the trust is revocable, the individual who created the trust retains full control over all trust assets. 

This control includes the ability to transfer property from the trust back to individuals if they choose to do so. Therefore, assets placed in a revocable trust are generally not protected by the creditors who created the trust. In other words, if a person creates a revocable trust and transfers property to it, and then incurs some major liabilities, such as a judgment from a creditor, the creditor can still attach and enforce the property in most cases. 

In doing so, this would satisfy judgment.

Taxes

The next difference between irrevocable and revocable trusts is related to federal estate taxes. At present, married couples can enjoy an asset tax exemption of $22 million in their estate before paying any type of federal estate tax. In other words, unless their estate is worth more than $22 million, a couple does not have to pay any type of federal estate tax. 

For couples whose estates exceed this amount, trusts can be a useful estate planning tool that can help them avoid paying federal estate taxes. However, the real key lies in whether a revocable or irrevocable trust is used.

Since revocable trusts can be modified or even revoked, they cannot be used as a way to avoid paying federal estate taxes for estates exceeding $22 million. However, irrevocable trusts can be used for this cause.

Protect Your Family with Irrevocable Differences

At Doane & Doane, we pride ourselves on our personalized legal services. We recognize that each family is different and that each family’s estate planning needs will also be different. 

Whether your family would benefit from a revocable or irrevocable trust is a question only you can answer. We highly encourage you to give careful consideration to both the pros and cons of each before making a final decision. 

Our legal team has extensive experience in estate planning and is here to help you make informed decisions about your wealth management for generations to come. 

You can reach us directly at 561-656-0200 or fill out our online contact form. 

Note:

The information in this blog post is provided for informational purposes only and is not intended to be legal advice. You should not make a decision whether or not to contact an attorney based upon the information in this blog post. No attorney-client relationship is formed nor should any such relationship be implied. If you require legal advice, please consult with an attorney licensed to practice in your jurisdiction.