Revocable vs. Irrevocable Trusts

Revocable vs. Irrevocable Trusts

A trust is a legal agreement where a third party, known as the trustee, manages assets or property for the benefit of one or more beneficiaries. Trusts are commonly used in estate planning to facilitate the transfer of assets, avoid probate, and reduce estate taxes. They can be customized to meet specific goals and come in different forms depending on their purpose. The two types of trusts are revocable and irrevocable.

Revocable Trusts

A revocable trust can be modified, amended, or terminated by the grantor during their lifetime. The flexibility of revocable trusts makes them relatively straightforward to establish, with the grantor retaining control over the trust’s assets. One of the significant advantages of a revocable trust is they typically allow assets to bypass the probate process, saving time and potentially lowering estate taxes. However, it is important to note that upon the grantor’s passing, a revocable trust usually becomes irrevocable.

An example, consider a revocable trust established by John, who names himself as both the grantor and trustee. He transfers ownership of his assets into the trust and designates his children as beneficiaries. John retains complete control over the trust and can change its terms as needed during his lifetime. If John dies or becomes incapacitated, the designated successor trustee manages the trust according to John’s instructions.

Benefits of a Revocable Trust

  • Flexibility: Grantors can adjust or dissolve the trust during their lifetime, allowing changes to beneficiaries, assets, or terms as situations evolve.
  • Probate Avoidance: Assets held in a revocable trust generally bypass probate, which can expedite distribution and reduce costs and delays. It is important to understand that this does not mean that a revocable trust avoids federal and state inheritance and estate tax. What the term “probate avoidance” means is that trust avoids the supervision of the Probate Court.
  • Privacy: Revocable trusts are typically not part of public records, unlike wills, offering greater privacy regarding the distribution of assets.
  • Simplicity: Revocable trusts are considered “disregarded entities” for tax purposes, which means there is not a separate tax filing requirement; the income is reported on the individual’s personal tax return until their death at which time a separate tax entity is created.

Disadvantages of a Revocable Trust

  • Potential Funding Challenges: Failure to properly fund the trust can result in assets being subject to probate, defeating the purpose of probate avoidance.
  • Limited Asset Protection: Revocable trusts do not offer the same level of asset protection as irrevocable trusts, as assets remain accessible to creditors and legal judgments.
  • No Direct Tax Benefits: While revocable trusts can help avoid probate, they do not inherently offer estate tax or income tax benefits.

Irrevocable Trusts

An irrevocable trust cannot be altered or revoked once it is established and funded. The grantor gives up control over the assets in the trust. The primary reasons for creating irrevocable trust are to achieve tax benefits and asset protection. Assets within an irrevocable trust are generally removed from the grantor’s estate, potentially reducing estate taxes. Additionally, these assets are usually protected from creditors and legal judgements.

An example of an irrevocable trust is when Mary creates an irrevocable trust for her son’s education. As the grantor, Mary contributes a significant amount to the trust, with terms stating that the funds can only be used for educational expenses. Once the assets are transferred, Mary loses control and cannot alter the trust’s terms. This arrangement offers tax benefits and asset protection for her son.

Benefits of an Irrevocable Trust

  • Tax Benefits: Irrevocable trusts can provide substantial tax advantages by reducing the taxable value of the grantor’s estate, potentially minimizing estate taxes.
  • Asset Protection: Assets within an irrevocable trust are typically shielded from creditors and lawsuits.

Government Benefits: By placing assets in an irrevocable trust, a grantor may not need to deplete their savings to qualify for government assistance like Medicaid, helping preserve wealth for future generations.

Disadvantages of an Irrevocable Trust

  • Loss of Control: The grantor relinquishes control over assets placed in an irrevocable trust.
  • Complexity and Expense: Irrevocable trusts tend to be more complex and costly to establish and maintain, often requiring legal and professional assistance.
  • Rigid Terms: Once established, irrevocable trusts typically cannot be amended easily, limiting flexibility to respond to changing circumstances or preferences.

Contact our experts today for help determining which trust is right for you and your estate!

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2024-07-10T18:21:43+00:00July 10th, 2024|Business|

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