Trusts are useful tools that offer protection for your assets and allow your loved ones to retain more of what you leave for them.
However, there's more than one type of trust. So how do you know which one is best?
It’s important to pick the right trust for your specific situation. Two of the most common types of trusts are revocable and irrevocable trust.
First, you have to know the differences between a revocable and irrevocable trust. To help you understand exactly what they are, we're here to explain what they are and how they compare.
What Are Trusts?
A trust is a legal relationship in which one party (a grantor) gives another party (a trustee) the right to hold assets on behalf of a third party (a beneficiary). These three parties can be one person.
For example, many grantors are also the trustees for revocable trusts. This allows them to maintain control of the assets within the trust during their life.
Trusts are a useful aspect of almost any estate plan.
There are many advantages to setting up trusts, including:
Keeping assets private
What is a Revocable Trust?
A revocable trust, or living trust, is used to designate assets after death. However, you'll also maintain a lot of control over it during your lifetime.
It has several advantages: avoiding probate, allowing the creator to maintain control over assets, being easy to change during your lifetime, and keeping finances out of the public eye once assets are distributed from the trust.
It’s called a revocable trust because it can be easily changed or even revoked. This allows the grantor to add or remove assets at will. Also, they have the authority to dissolve the trust entirely.
What is an Irrevocable Trust?
Similar to a revocable trust, an irrevocable trust designates the belongings in the trust after death. It also keeps finances private and can allow you to avoid probate. However, it can't be changed or dissolved after it's completed and signed.
Irrevocable trusts shift ownership from the grantor (or creator of the trust) to the trust and its beneficiaries. This means it's safe from any legal repercussions or creditors the original owner of the assets could be on the hook for.
The main pro of an irrevocable trust is that it can help save money on taxes, especially when it comes to larger estates.
Major changes in circumstances may allow an irrevocable trust to be changed. For example:
Changes in tax code
Changes in inheritance law
Death of a beneficiary
Birth of family member
Differences Between a Revocable and Irrevocable Trust
There are a few key differences between a revocable trust and an irrevocable trust. Each has its pros and cons.
Revocable Trusts Are Easily Modified or Dissolved
As the grantor, you can easily modify or dissolve a revocable trust. Anything can be added or taken out of the trust at any time, so long as the grantor is in a sound state of mind.
On the other hand, you can only change an irrevocable trust under specific conditions. For example, it can be amended by the trustee or beneficiary if they are given lifetime power to change the trust. In this case, they would be exercising what is known as the power of appointment to alter the trust.
By putting the power of appointment language in a trust, it gives the person of your choice responsibility for the contents of the trust after death.
You can also petition in court for your irrevocable trust to be modified. To successfully do this, you will need to provide a judge with a good reason as to why you need the trust changed, such as the death of a beneficiary, changes in tax code, or the birth of a new family member.
The bottom line here is that if you want the ability to easily modify or dissolve your trust, a revocable trust is likely the better option.
A Revocable Trust Retains Ownership of Assets
While technically, the assets in revocable and irrevocable trusts are owned by each respective trust, the assets in a revocable trust aren’t treated as such.
The grantor still has control over the assets in a revocable trust but has no say in what is done with assets in an irrevocable trust.
When an irrevocable trust is set up, those assets are now owned by the trust and its beneficiaries. The grantor essentially loses control of these assets, and can only make changes with approval from the beneficiaries.
Now, depending on your situation, this could be a pro or a con. If you want to maintain full control over your assets during your lifetime, a revocable trust is the best solution.
Irrevocable Trusts Provide Asset Protection & Tax Savings
An irrevocable trust will protect your assets and provide tax-shelter benefits.
So, while you don't maintain ownership, those assets are now safe from creditors, potential lawsuits, and you'll save big on estate taxes.
This is because the trust truly owns the assets. Because of this, the grantor has no access to it and creditors can not try to lay claim over it.
Sometimes, an irrevocable trust is recommended for professions that are more prone to lawsuits, such as doctors or lawyers.
On the other hand, creditors can usually attach the grantor to a revocable trust since they maintain control and access to the assets in it.
Key Takeaways of a Revocable Trust vs. Irrevocable Trust
Now that each component of revocable and irrevocable trusts has been detailed, here are a few key features of each type of trust.
Can easily be modified or dissolved
Can avoid probate
Keeps finances out of the public record
Allows protection in the event of incapacitation
No protection from creditors
No tax savings
Tax-free up to about $22 million
Protection from creditors
Difficult to modify
You don’t own the contents of the trust
You have no control of the trust's contents
Still Don’t Know Which Type of Trust is Best for You?
If you still can’t decide which, if any, trust is right for you, don’t worry! We can help determine what is best for your specific situation.