A living trust is a legal entity you (the grantor) establish to hold your assets during your lifetime. After your death, this trust dictates how those assets should be distributed. As the creator of this living trust, you can appoint an individual or institution (trustee) to manage it for the future benefit of your beneficiaries.
There are two main types of trusts: irrevocable trusts and revocable trusts.
This article describes the differences and advantages of revocable vs. irrevocable trusts. It can help you decide which type of living trust is right for you.
What is the difference between revocable and irrevocable trusts?
The main difference between a revocable trust vs irrevocable trust is in the amount of control you have over assets placed in the trust once it’s created. A revocable trust can be altered at any time, while an irrevocable living trust cannot be modified or revoked.
In addition to control, there are other notable differences between revocable and irrevocable trusts that you should be aware of.
When deciding between a trust vs. will, grantors with complex estates often choose living trusts because such trusts don’t have to go through a probate process.
What is a revocable living trust?
The grantor can modify or revoke a revocable living trust at any time. Assets in a revocable trust are still legally owned by the grantor until they’re distributed to beneficiaries after death. Any income generated by the trust is distributed to the grantor and must be filed with their taxes.
After the grantor’s death, a revocable trust becomes irrevocable.
Advantages of a revocable trust
Grantors may choose revocable over irrevocable trusts for the following reasons:
1. Control over assets and beneficiaries: You can make changes to a revocable trust throughout your lifetime. That includes adding or removing assets, and changing beneficiaries.
2. Ability to revoke: You can revoke the trust at any time if you decide you no longer want your assets in a trust. This allows you to easily access funds in an emergency.
3. Security: Although you may want control over your trust for the foreseeable future, a revocable trust allows you to appoint a trustee who can oversee your interests in the event you become incapacitated. You can leave instructions to the trustee (like how you want your assets distributed), and they are legally obligated to follow them.
What is an irrevocable trust?
An irrevocable trust can’t be altered or terminated by the grantor after it’s established unless the beneficiary or beneficiaries agree to the changes. Once you sign the contract, your assets are moved out of your estate, and you legally relinquish ownership and control.
You might be thinking, why would anyone choose an irrevocable over a revocable trust?
Advantages of an irrevocable trust
Despite their rigidity, there are still advantages of creating an irrevocable trust:
1. Asset security: Since assets in an irrevocable trust are no longer a part of the grantor’s estate, they can’t be used to pay debts or lawsuits. However, a revocable trust remains subject to lawsuits because the assets contained in the trust technically still belong to the grantor. This means the value of the assets in a revocable trust can be collected to settle any payments owed or awarded in court.
2. Reduce estate taxes: In a revocable trust, if assets left to beneficiaries exceed the IRS lifetime tax-free gift limit, they will be subject to a 40% federal estate tax. Assets gifted to beneficiaries through an irrevocable trust are exempt from estate taxes but may be subject to gift taxes.
3. Government benefit eligibility: Because you give up ownership of your assets, their value is no longer considered when applying for government assistance programs. For example, you are ineligible for Medicaid if you have “countable” assets over a specific value.
4. Charitable Donations: An irrevocable charitable trust allows you to name a charity or charities as beneficiaries. Contributions made to the trust during your lifetime can be claimed as charitable deductions on your income taxes. If the transfer of assets occurs after the grantor’s death, the estate will process the charitable estate tax deduction.
Revocable trust vs irrevocable trust: which one is right for you?
Now that you understand the difference between the two trusts, you can select the right one to meet your needs.
An irrevocable trust is ideal if you’re looking for tax exemptions, want to make charitable donations, desire government assistance, or fear potential lawsuits/debt collections. However, in return for the benefits of an irrevocable trust, your assets are permanently transferred out of your estate, and you’ll no longer have any control over or access to these assets.
A revocable trust is a better choice if you want to retain control over your assets and beneficiaries as well as have the ability to terminate your trust. Since you’re still the legal owner of the assets in the trust, they won’t be protected from legal action and debt collection, avoid estate taxes, or be eligible for charitable income tax deductions.
Related: Setting Up a Trust: Living Trust Cost & Checklist
It’s important to note that the tax implications of an irrevocable trust are complex and varied. Therefore, we recommended consulting an attorney before choosing between a revocable vs irrevocable living trust.