Understanding Irrevocable and Revocable Trusts: Which One Do You Need?
At the core of any effective estate plan is a well-executed trust, which, in turn, begins with the question: What kind of trust do I need?
A trust is a fundamental estate planning tool that offers protection, control, and efficiency in managing the assets of a deceased individual. It comes in two foundational types: irrevocable and revocable trusts, each serving different purposes.
This post breaks down what each trust does, how they work, and which one might work best in your situation.
What is a Trust?
In general, a trust is a legal entity that holds assets for the benefit of a person or group. There are three roles involved in this legal arrangement:
Trustor (also called Grantor or Settlor): The person who creates the trust.
Trustee: The person or institution responsible for managing the trust.
Beneficiary: The person or people who will receive the benefits or assets under the trust.
Almost any type of asset can be put in a trust: homes, bank accounts, investments, life insurance, and even business interests. In a trust, the grantor can specify how these assets will be managed and distributed upon their death, often avoiding the delays and expenses due to the probate process.
While all types of trusts share this basic framework, the difference between revocable and irrevocable trusts lies in this key question: Who has control once the trust is created?
Revocable Trust: Flexibility and Control
A revocable trust, also called “revocable living” trust or “living” trust, is, as these names suggest, the type where the grantor can change, amend, or cancel the trust during their lifetime.
How It Works
If you, for example, set up a revocable trust, you become both the grantor and your own trustee while still living. This means that you retain full control over your assets: you can sell, gift, or manage them however you like. You can add or remove beneficiaries and even dissolve the trust should your goals or circumstances change.
Upon your death, your revocable trust automatically becomes irrevocable. Your successor trustee steps in to execute the terms of your trust, including managing your assets, distributing the inheritance to the beneficiaries, and following other instructions. These steps happen privately and outside of probate or the court-supervised process of transferring an estate.
Benefits of a Revocable Trust
Flexibility - You can update your revocable trust as your life evolves; be it marriage, divorce, children, major purchases, windfall, or successful businesses.
Avoids Probate - Assets protected under a revocable trust avoid probate, ensuring fast and private asset distribution to your beneficiaries.
Privacy - Unlike a will, revocable trust documents will not become part of the public record upon death, thus keeping your personal and financial affairs private.
Continuity - If you become incapacitated, your revocable trust allows the seamless transfer of your responsibilities to your successor trustee, without the need for court-appointed guardianship.
Potential Drawbacks of a Revocable Trust
No Asset Protection - Because you are the trustee while living, you maintain ownership and control over your assets. Thus, in a revocable trust, these assets are still subject to claims by creditors, lawsuits, or divorce settlements.
Part of a Taxable Estate - Having your assets in a revocable trust does not reduce your estate taxes, because while still living, these assets are still considered part of your taxable estate.
No Income Tax Benefits - The assets in your revocable trust are still filed under your Social Security Number. As such, any income from these assets during your lifetime must still be reported and subject to your personal taxes.
Irrevocable Trust: Protection and Permanence
An irrevocable trust, obviously the opposite of a revocable trust, is the type that you cannot change, amend, or cancel. There are instances where you can, but you would need the consent of the beneficiaries or court approval.
How It Works
Similar to creating a revocable trust, you set up an irrevocable trust by transferring your assets into the trust. However, once you transfer your assets and your irrevocable trust takes effect, you are effectively giving up ownership and control.
Your irrevocable trust, managed by the trustee you appointed, becomes the new owner of the assets. You generally cannot take those assets back or change the terms of the trust. While lacking in flexibility, an irrevocable trust makes up for it in protection and tax advantages.
Benefits of an Irrevocable Trust
Asset Protection - This is the main advantage of an irrevocable trust. Because you no longer own the assets, they are shielded from your creditors, lawsuits, or divorce claims.
Tax Advantage - Assets transferred into an irrevocable trust are removed from your taxable estate, reducing estate and gift taxes.
Separate Tax Entity - An irrevocable trust is given its own tax ID number and files its own return. Often, this leads to reduced income taxes because trust income tax has lower rates compared to individual income tax.
Wealth Preservation - Irrevocable trusts are ideal for protecting family wealth for future generations or charitable causes.
Long-Term Care Planning - Some types of irrevocable trusts let you qualify for Medicaid benefits while preserving your assets for your loved ones.
Charitable Giving - An irrevocable trust is also useful for philanthropic purposes, allowing you to support your favorite cause with added tax benefits.
Potential Drawbacks of a Revocable Trust
Loss of Control - Once transferred into an irrevocable trust, your assets are no longer legally yours, preventing you from accessing or benefiting from them.
Gift Tax Considerations - Adding assets to an irrevocable trust is treated as a completed gift and is subject to gift tax if the gift exceeds the gift tax exemption limit.
Complexity - Irrevocable trusts have complex structures and formats, often requiring expert legal guidance for drafting, execution, and ongoing administration.
Cost - With complexity comes cost. To maintain the powerful protection and permanence, an irrevocable trust involves more legal management expenses than a revocable trust.
FAQ: Can an irrevocable trust ever be changed?
Answer: No, in most cases. Some states allow changing the trust only with the consent of the beneficiaries or upon a court's decision. In a specific instance, an irrevocable trust can be changed if it was initially set up to allow “trust decanting.” Through this strategy, the trustee of an irrevocable trust can transfer the assets into a new trust with updated terms. This is only possible through expert legal guidance and forward-thinking planning.
Revocable Trust vs. Irrevocable Trust
Here’s a quick side-by-side comparison between revocable and irrevocable trusts:
Feature
Revocable Trust
Irrevocable Trust
Control
Retained, can modify and cancel trust
Relinquished, no longer the owner of the assets
Ownership
Assets are still legally the grantor’s
Assets are owned by the trust
Avoids probate
Yes
Yes
Asset Protection
None while grantor is living, only upon death
Strong protection from creditors, lawsuits, and divorce claims
Income Tax
As personal tax return
As trust tax return
Estate and Gift Tax
No benefits
Reduced estate tax, asset transfers can trigger gift tax rules
Privacy
Yes
Yes
Complexity
Simple and easy to manage
Requires legal professional expertise
Best For
Flexible planning while avoiding probate
Asset protection, tax reduction, and legacy planning
Choosing the Right Trust for You
When deciding between a revocable and irrevocable trust, start with your estate planning goal:
I want flexibility and control during my lifetime. > Revocable Trust.
I only want to avoid probate and maintain privacy. > Revocable Trust.
I want a low-cost and easy-to-set-up trust. > Revocable Trust.
I need to protect my assets from creditors or lawsuits. > Irrevocable Trust.
I must minimize the taxes on my assets. > Irrevocable Trust.
I am planning for long-term care or Medicaid eligibility. > Irrevocable Trust.
I want to support a charity. > Irrevocable Trust.
I need to preserve my wealth for future generations. > Irrevocable Trust.
In most cases, you don’t have to choose, meaning your estate plan can include both types. This is where understanding your assets comes into play. For example, you can have a revocable trust containing your everyday assets or those you need to access and manage. Alongside this, you can set up an irrevocable life insurance trust (ILIT) for keeping your life-insurance proceeds outside your taxable estate.
When Creating a Trust, Legal Guidance Matters.
While simple in theory, trusts become complex when put into practice. This is because they must fit seamlessly with your goals, personal situation, asset portfolio, and existing estate planning tools (such as a will, power of attorney, etc.). If these factors are not accounted for, even a well-drafted trust will lead to confusion, dispute, and unnecessary taxes.
Fortunately, you can turn to experts like Rilus Law for professional legal guidance, ensuring that your trust, whether revocable or irrevocable, properly reflects your family dynamics, financial goals, and long-term vision. Trust us in helping you design or update an estate plan that meets your needs today and safeguards your legacy tomorrow.
Schedule your free consultation by sending us a message here.