A revocable trust is a living trust that gives you control over how your assets are managed and distributed after your death. An irrevocable trust is a permanent arrangement that gives you tax benefits and protects your assets from creditors and judgments.
While death isn’t a typical topic of conversation for a Sunday brunch, it’s still worth discussing at some point because it’s one of the few things in life that’s inevitable. Before you pass away, you’ll want to avoid leaving anything up to chance. Integrating a living trust into your estate plan is a strategic way to manage your assets and pass down your legacy according to your own plans.
There are two types of trust: a revocable (living) trust and an irrevocable trust. The key differences between them lie in their flexibility. When a grantor creates a revocable trust, they name the trust’s beneficiaries and lay out the terms. The grantor can then change those terms or abolish the trust as they see fit. On the other hand, when a grantor creates an irrevocable trust, they cannot change it because the trust’s assets no longer belong to them.
While both are excellent estate planning tools, understanding the difference between a revocable trust and an irrevocable trust can help you determine which will better fit into your financial goals. Let’s take a closer look at how revocable and irrevocable trusts work to help you choose the right type of trust for your estate planning needs.
What is a revocable trust?
Revocable trusts, also known as living trusts, can be altered at any point during the grantor’s lifetime. When you pass away, your revocable trust will automatically become irrevocable, and the successor trustee (typically a relative or a trust company) will continue to oversee your trust assets. Unlike with a will, the named beneficiaries won’t have to undergo a lengthy and often costly probate process (court-supervised administration of an estate) to authenticate the trust and transfer assets.
Pros and cons of revocable trusts
The temporary nature of a revocable trust makes it a particularly popular estate planning tool. Life is unpredictable, so many people prefer to keep the terms of their trust flexible in case circumstances change.
That said, revocable trusts also have their disadvantages. For one, this type of trust is not the best vehicle to reduce income taxes or protect your assets from creditors. Drawing up a revocable living trust may also be more expensive than creating a will on your own, as it requires hiring attorneys and paying court filing fees.
The following are some of the main advantages and drawbacks of revocable trusts:
Here is a list of the benefits and the drawbacks to consider.
- Maintain control of assets
- Add or remove beneficiaries
- Bypass probate process
- No tax benefits
- No creditor protection
Pros of a revocable trust
- Maintain control of assets — With a revocable trust, you retain the power to modify and revoke the terms of your trust at any time. If you change your mind about anything in your estate plan — for example, which of your beneficiaries should receive a specific asset — you can alter the terms of the trust without any legal hassle.
- Add or remove beneficiaries — If the dynamics of your family change — due to marriage, divorce, death, fallings-out, etc. — you can add or remove beneficiaries without altering the original terms of the trust.
- Bypass probate process — Probate is a public process, meaning anyone can see the size of your estate and the specifics of your trust. Additionally, going through probate court is often lengthy and expensive; you may need to hire attorneys and accountants, all of whom charge fees for their services. With a revocable trust, you can protect your privacy and save money and time by bypassing probate.
Cons of a revocable trust
- No tax benefits — Because you’re the trust owner, your assets are still under your name, which means you won’t see a reduction in your income taxes.
- No creditor protection — Revocable trusts offer no creditor protection, which can be inconvenient if you incur a heap of debt. Even if you keep your assets in a trust, creditors can repossess them and force you into bankruptcy.
What is an irrevocable trust?
Similar to a revocable trust, an irrevocable trust is a legal arrangement created to hold and manage your assets. The difference is that with an irrevocable trust, you cede control over the trust property. This type of trust is akin to a financial tattoo: once it’s created, you can’t easily change or revoke it. Changing the terms of an irrevocable trust, while technically possible, requires overcoming legal hurdles that aren’t necessary with a revocable trust.
However, just because a grantor can’t alter the terms of an irrevocable trust doesn’t mean it can’t be changed by others, explains Bruce Tannahill, Director of Estate and Business Planning with MassMutual. “The trust agreement and state law determine who may be able to change the trust and the process that must be followed to make changes,” says Tannahill. “Over the past 20 to 30 years, changes in state law and how trust agreements are drafted often provide at least two ways for trust provisions to be changed if they no longer accomplish the trust’s original purpose.”
Understandably, irrevocable trusts are a less popular option than revocable trusts. That said, an irrevocable trust can still meet certain sophisticated estate planning needs.
Types of irrevocable trusts
The following are some of the subtypes of irrevocable trusts you can set up for your estate:
- Credit shelter trust (or AB trust): An AB trust is often utilized by married couples to minimize estate taxes. When one spouse dies, the assets are transferred into the surviving spouse’s trust. When the surviving spouse dies, the remaining trust is transferred to the grantor’s heirs tax-free.
- Qualified terminable interest property trust (QTIP): When one spouse dies, the trust provides income to the surviving spouse. When the surviving spouse dies, the assets are transferred to a surviving beneficiary.
- Qualified domestic trust (QDOT): This tax-exempt irrevocable trust works like a QTIP trust, except that it applies to a surviving spouse who is a noncitizen.
- Grantor-retained annuity trust (GRAT): A GRAT transfers assets out of a taxable estate to reduce taxes for its beneficiaries. During this time, grantors will temporarily have access to income before the beneficiary receives the trust.
- Qualified personal residence trust (QPRT): This type of trust works similar to a GRAT in that the grantor can temporarily live on a property before gifting it to their heirs.
- Spousal lifetime access trust (SLAT): This trust gradually transfers assets out of the grantor’s estate. However, the benefactors receive distributions to support the grantor.
- Generation-skipping trust: Grantors can gift trusts to grandchildren while minimizing estate taxes.
- Dynasty trust: Like a generation-skipping trust, a dynasty trust allows grantors to transfer assets without paying a significant amount on taxes.
- Spendthrift trust: This trust is for beneficiaries who may be incapable of managing money after a trust creator passes away. For instance, if a child has displayed irresponsible money management, the grantor may want to outline terms for limited money distribution toward the inheritor.
- Special needs trust: This trust is for individuals who have dependents with disabilities. It allows parents to pass on their inheritance without making their child ineligible for government assistance.
- Irrevocable life insurance trust (ILIT): This trust acquires its assets from the death benefit of a life insurance policy.
- Charitable remainder trust: A charitable trust is intended to fund a charity of the grantor’s choice after their death and the deaths of their beneficiaries.
- Asset protection trust: This type of trust is designed to protect the grantor from creditors.
Pros and cons of irrevocable trusts
Like a revocable trust, an irrevocable trust allows you to protect your privacy by bypassing probate. Since the assets are no longer under your name, you can also shield your investments from judgments and creditors. Additionally, with limited income, you may receive a more favorable tax treatment than you would get from a revocable trust.
However, despite their tax benefits and creditor protection, irrevocable trusts have their own share of downsides. By setting up an irrevocable trust, you’ll be permanently relinquishing all control over the assets in your trust. Irrevocable trusts are also more difficult and expensive to set up, which explains why most grantors opt for revocable trusts instead.
Here are some of the major benefits and disadvantages of irrevocable trusts:
Here is a list of the benefits and the drawbacks to consider.
- Avoid estate taxes
- Protect assets from creditors
- Access to government benefits
- Lack of flexibility
- Complicated tax process
Pros of an irrevocable trust
- Avoid estate taxes — One of the primary reasons some people choose to house their assets in an irrevocable trust is to sidestep estate taxes. You must pay federal and state taxes on your estate before your assets can be distributed to your beneficiaries. According to the IRS, as of 2023, the estate tax exemption is $12.06 million per person. If the assets in your trust are more than $12.06 million, the IRS may subject you to federal estate taxes of up to 40%. If you have a larger estate and want to save your heirs the stress of a hefty annual tax bill, an irrevocable trust may be a good solution for you.
- Protect assets from creditors — Irrevocable trusts shield your assets from creditors in case you incur some sort of debt while you’re alive. For instance, if you work in the medical industry and someone were to sue you for injuries or illness due to negligence, you wouldn’t need to worry about losing all your assets because the trust is not under your name. This is also true if you have outstanding debts: creditors can’t reach into your irrevocable trust to pay off your financial obligation because the trust belongs to your beneficiaries.
- Access to government benefits — Because your irrevocable trust’s assets are not included in your net wealth, you may end up qualifying for government assistance programs for individuals with less income, like Medicaid or Supplemental Security Income (SSI). In essence, an irrevocable trust offers a way for you to leave assets to your heirs by removing them from your overall wealth before you’ve died.
Cons of an irrevocable trust
- Lack of flexibility — Once you make a trust irrevocable, you lose control over what assets will be transferred to your beneficiaries and how they will be distributed. The only way to amend an irrevocable trust is through a court order, unless all beneficiaries agree to the change.
- Complicated tax process — “Tax-exempt” doesn’t always mean a less complicated tax situation. Setting up an irrevocable trust involves separate tax identification numbers and tax returns. If you need to hire experts, like estate attorneys and accountants, to aid you in the process, an irrevocable trust may end up costing you more work than its worth.
Revocable and irrevocable trust: which one is better?
Elina Yuabov, a finance attorney at Yuabov Law Group PLLC, mentions that the trust that’s best suited for an individual is contingent on several factors, including wealth status, principal place of residency, property ownership outside of principal residency, children, marital status, need for creditor protection, tax circumstances, and privacy concerns.
Generally, revocable trusts are relatively easy to create, and you won’t need to worry about losing control over your assets once the trust is established. So if you’re an individual with a low-risk profile looking for a more straightforward solution, a revocable trust is likely your best bet.
On the other hand, an irrevocable trust requires additional steps as far as creation and ongoing maintenance. That said, if you have a more complicated financial situation, you need protection against creditors or judgments, or you want to reduce your estate tax burden, then an irrevocable trust might be the better option for you.
Is a revocable trust better than an irrevocable trust?
When it comes to the revocable-vs.-irrevocable-trust comparison, you’ll want to consider your needs. Revocable trusts are popular due to their flexibility, while irrevocable trusts tend to attract those who want to reap certain tax benefits and keep creditors away from their assets.
Why would you make a trust irrevocable?
Although irrevocable trusts are permanent, they do offer some advantages, including substantial estate tax benefits, privacy from creditors, and potential access to government programs for reduced income, like SSI and Medicaid.
What is the downside of an irrevocable trust?
There are multiple downsides to irrevocable trusts. Notably, they are more complicated to set up than revocable trusts, and once you create an irrevocable trust, you will lose control over your own assets, as well as the ability to alter the terms of the trust.
What is one of the main advantages of a revocable trust over an irrevocable trust?
Revocable trusts allow grantors to retain jurisdiction over the assets in the trust. This includes the option to amend the terms of the trust and to change and remove beneficiaries.
Can the IRS take your irrevocable trust?
No, the IRS cannot confiscate the assets you keep in an irrevocable trust because they no longer belong to you.
- The main difference between revocable and irrevocable trusts is that a revocable trust can be revised or canceled entirely, while an irrevocable trust’s terms are permanent.
- With a revocable trust, you have complete control over your assets, but you gain no tax benefits and your assets are still subject to creditors.
- With an irrevocable trust, you forfeit control over your assets. In exchange, you receive protection from creditors, estate tax exemptions, and potential access to government benefits.
- The type of trust that’s better for you depends on your estate planning needs and unique circumstances. The flexibility and simplicity of a revocable trust make it the more popular option, but if your financial situation is more complex, an irrevocable trust may better suit your needs.
Creating a trust is a significant decision, and if you designate a financial advisor as your trustee, you’ll want to ensure the firm you work with acts in good faith. Luckily, SuperMoney can help you make that process easier. Start by reading our guide on how to find a financial advisor you can trust, then use our comparison tools to find the best wealth management firms for your needs!
View Article Sources
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- Abusive Trust Tax Evasion Schemes – Questions and Answers – Internal Revenue Service
- What Is a Successor Trustee? Duties & Powers – SuperMoney
- Two Names on Deed, One Person Dies, What Then? – SuperMoney
- How the Rich Use GRATs to Get Richer – SuperMoney
- How to Find a Financial Advisor You Can Trust – SuperMoney