It's a Matter of Trust: Revocable or Irrevocable? That is the Question

When people’s attention eventually turns to planning their estate, they are suddenly confronted with a new language replete with the kind of legalese and Latin terms that only a lawyer can love, and that’s mainly because lawyers are typically the only people who can understand it. Among the more mysterious terms are the various types of trusts which are used in estate planning; and two of the more popular trusts in particular – Revocable Trusts and Irrevocable Trusts – are often confused with one another. Here we demystify these two popular and very useful estate planning tools.

The Difference between Revocable and Irrevocable Trusts in a Nutshell

The clue to understanding the primary difference between a revocable trust and an irrevocable trust is in their names:

Revocable – able to be invalidated

Irrevocable – impossible to revoke

So, a revocable trust can be revoked, invalidated, or changed at will by the trust grantor or trustor and an irrevocable trust, once established, cannot. With a revocable trust, the trustor can place assets inside it, change their mind and take them out up until the time the trustor dies, when in most jurisdictions, it becomes irrevocable. Once an asset is placed inside an irrevocable trust, it is considered a gift to the trust and cannot be revoked.

With that as the main backdrop, it then is important to understand their distinction in terms of how they are used in estate planning. Essentially, a revocable trust is used to keep assets out of probate while an irrevocable trust is used to remove assets from the estate. These are two completely different estate planning objectives which is why they require two different kinds of trusts. So, the most important thing you need to understand is what you want to accomplish with your estate.

Planning for Estate Distribution

For example, if the value of your estate is less than $5 million and your primary objective is to protect your family from the cost, time, and publicity involved in settling your estate, a revocable living trust your solution.  With the current estate tax exemption, your estate will pass tax free to your spouse, so, currently, you don’t need an irrevocable trust. Other reasons for establishing a living trust might include:

Planning for Estate Preservation

However, if the size of your estate exceeds $5 million and is expected to grow, your estate will be subject to estate taxes up to the maximum 40 percent tax rate. And taxes owed are paid out of the estate which reduces the amount of assets available to your family. So, you may have as an objective to maximize your estate for your family by reducing the tax burden. The only way to do that is to remove assets from your estate, and one solution available to you is an irrevocable trust.

Revocable Trust Basics

Also referred to as a “living trust” or an “inter vivos” trust, a revocable trust is a legal arrangement in which you as the grantor, grant your assets to the trust which is overseen by a trustee (which can also be the grantor). In essence the trust becomes the owner of the assets, but as the grantor you have control over the assets – which to include, their beneficiaries, how they are managed. You maintain this control until the day you die at which point a successor trustee (either your spouse or someone named by you in the trust document) takes over. At your death, the trustee takes on a fiduciary duty to ensure sure the provisions of the trust are executed to the letter and in a timely manner.

At the time of the estate settlement, the trust assets can be distributed directly to the named beneficiaries without having to go through probate proceedings. However, your assets are still includable in your estate for estate tax purposes.

A living trust is a fairly straightforward document and can be drawn by an attorney for less than $1,500, or it can be obtained through an online legal service like LegalZoom.com. It is always advisable to have your living trust reviewed by an attorney periodically as life circumstances dictate.

Irrevocable Trust Basics

An irrevocable trust can be a somewhat more complex legal arrangement requiring the help of an attorney. Because there could be current income tax and future estate tax implications in the use of the trust, it’s advisable to work with an estate attorney to draft it.

As with a revocable trust, an irrevocable trust has a grantor, the person who grants or gifts the assets, a trustee, and a beneficiary. The biggest difference is that that grantor no longer maintains control over the trust assets after the grant. Of course, as the grantor, you can dictate the terms, rules and uses of the trust assets; you just can’t change them without the consent of the trustee and the beneficiary.

There are number of reasons why you might establish an irrevocable trust:

• To take advantage of the estate tax exemption and remove taxable assets from your estate.
• To prevent assets from being misused by beneficiaries; assets can be held in trust and distributed with conditions.
• To be able to gift assets or remove them from your estate while still retaining the income from the assets.
• To remove appreciable assets from your estate while still providing your beneficiaries with a step-up basis in valuing the assets for tax purposes.
• To gift a principle residence to your children under more favorable tax rules.

One of the primary uses of an irrevocable trust is to house a life insurance policy which would effectively remove the death proceeds from the estate.

Once thought to be an estate planning tool for the wealthy, people of more modest means are finding plenty of uses for irrevocable trusts. While they probably have less value for people with less than $5 million in assets, it’s important to mindful of the fact that the estate tax laws, exemptions and tax rates change frequently which could increase their value to your estate plan at some point. They can cost more to create and to manage than a revocable trust, so its value would also depend on how much you are trying to protect.

To Trust or Not to Trust

At the very least, every family could benefit from a revocable living trust. The cost is minimal and they’re easy to administrate. However, it is extremely important to note that a revocable living trust and a Will are not the same. They are two separate legal arrangements and one cannot accomplish the objectives of the other. You still need a will, a power of attorney, and a medical directive all of which operate outside of a revocable trust.

Needless to say, it is strongly recommended to review your estate planning objectives with an estate attorney who can advise you on the suitability of any estate planning tool. 

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2024 Advisor Websites.