When thinking about estate planning and what you want to do with your assets after you’re gone, it can be helpful to consider different types of trusts. That way, you can make a more informed decision when deciding how best to transfer property or financial accounts and investments.
One key distinction in trusts is between revocable and irrevocable ones. Knowing the differences between these two types can help you decide whether a trust might work well for you. Let’s take a look at some factors that may come into play when making this choice.
What Does “Revocable” Trusts Mean?
A revocable trust allows its creator – known as the grantor – to change its terms or even dissolve it altogether. As a result, the grantor maintains control over the trust throughout its existence, and can direct its assets as they see fit while they are alive.
This type is sometimes called a “living trust” or “inter-vivos trust,” meaning it takes effect during one’s lifetime rather than when death occurs – making it an ideal solution for those who want to ensure that their beneficiaries receive property after their own life is over but want to maintain some influence in what happens to their possessions during life.
What Does “Irrevocable” Trusts Mean?
In contrast, an irrevocable trust cannot be changed once created; any changes must be authorized by the creator of the trust or by a court. This type of trust may be created for estate planning purposes, to minimize potential gift and estate taxes, or to protect assets from creditors.
Once an irrevocable trust is set up, the grantor typically surrenders all ownership and control over the property in question. That can have some advantages – for instance, if the grantor later needs to qualify for Medicaid, the value of property held in an irrevocable trust will not be counted as part of their “assets” for purposes of determining eligibility.
However, it also means that the grantor generally cannot change their mind about how the property should be used, or who should receive it. So irrevocable trusts are often only used in very specific circumstances where the grantor is absolutely certain about their wishes for the future.
Types of Irrevocable Trusts
There are several different kinds of irrevocable trusts that may be used to protect property, minimize taxes, or set up a distribution plan. Among these are:
【Answer 1】A marital trust – This type is often created in conjunction with a will as part of an estate plan, and can help a surviving spouse avoid being forced to sell their home or other valuable possessions in order to cover living expenses. A marital trust sets aside some money for the spouse’s benefit during his or her lifetime; the rest goes to designated beneficiaries when the second spouse dies.
【Answer 2】An asset protection trust – This type is typically created by people who have significant assets and want them protected from creditors’ claims or lawsuits that might arise after they are gone. Because the assets are held by the trust, they are no longer considered owned personally and shielded from creditors as a result.
【Answer 3】A special needs trust – This type is intended to provide for a disabled person while maintaining their eligibility for government benefits that may help pay for their care; once those needs have been met, the remainder of the funds can be used at the beneficiary’s discretion.
Which Type of Trust Is Right For Your Estate Planning?
Of course, it’s impossible to say which trust type will be best for you or your heirs without first consulting with an estate planning attorney.
However, there are some common situations in which revocable trusts work particularly well:
【Answer 1】People who anticipate changing tax laws before they die may want to use a revocable trust so they can take advantage of any new opportunities that arise.
【Answer 2】People who have young children or grandchildren may want to set up a revocable trust as part of their estate plan in order to ensure that those beneficiaries are taken care of financially if something happens to the grantor.
【Answer 3】People who own property in more than one state may find it easier to manage their affairs – and avoid probate – if they use a revocable trust rather than setting up separate wills for each state.
On the other hand, there are some specific circumstances where an irrevocable trust might be the right choice:
【Answer 1】People who are concerned about long-term care costs and are worried about becoming a burden to loved ones in the future may want to set up an irrevocable trust that can be used to pay for their long-term care expenses.
【Answer 2】People who own property or businesses that could be exposed to lawsuits, creditors, or other threats after they die may want to use an asset protection trust as part of their estate plan in order to ensure those assets will remain protected.
【Answer 3】People with special needs family members – including adults with disabilities, minor children, or grandchildren – may find it more convenient to create a special needs trust rather than setting up separate plans for each beneficiary. However, this type should always be created under close guidance from an experienced estate planning attorney.
Key Differences Between Revocable and Irrevocable Trusts
The main difference between revocable and irrevocable trusts, then, is that a revocable trust gives its creator more control over its terms – while an irrevocable trust, once created, cannot be changed.
There are a few other key ways in which these types of trusts differ:
1. How They Are Funded
Both revocable and irrevocable trusts can be funded during the grantor’s lifetime or after death, through provisions in the grantor’s will. However, funding a trust during life has some advantages.
For one thing, it can be a way to avoid probate – the legal process that is used to determine how a person’s property will be distributed after they die. Probate can be time-consuming and costly, so funding a trust during life can help your beneficiaries avoid this process.
Another advantage of funding a trust during life is that it can provide more flexibility in how the assets are used. For instance, if you fund a revocable trust during your lifetime, you can change the terms of the trust at any time – allowing you to adapt it as your needs or wishes change over time.
2. How They Are Taxed
The way trusts are taxed also differs depending on whether they are revocable or irrevocable.
Revocable trusts are not subject to separate taxation – the grantor is still responsible for paying taxes on any income generated by the trust. However, upon the grantor’s death, the trust may become taxable as part of their estate.
Irrevocable trusts, on the other hand, are typically taxed as separate entities. That means that the trustee – the person responsible for managing the trust – will need to file a separate tax return for the trust each year.
However, there are some types of irrevocable trusts that can provide tax advantages – for instance, if they are set up specifically for estate planning purposes. These types of trusts may be able to help minimize gift and estate taxes, depending on your circumstances.
3. How They Are Managed
One of the biggest differences between a revocable and irrevocable trust is in who manages each one. A revocable trust can be managed by a trustee during its creator’s lifetime – but after death, it becomes part of the estate, which must then go through probate. As a result, you may choose someone other than the executor named in your will to act as the trustee upon your death; however, one potential disadvantage is that they might not be able to manage those assets as well as an experienced professional could. Furthermore, heirs may decide to contest the appointment of this new trustee if they believe it was made with less-than-honourable intentions.
An irrevocable trust, on the other hand, must always be managed by a trustee – it cannot be part of the grantor’s estate. That means that you’ll need to choose someone to act as the trustee when you create the trust, and they will continue to manage it after your death. This can provide some advantages – for instance, it can help ensure that the assets in the trust are managed in accordance with your wishes. However, it also means that you’ll need to choose someone you trust implicitly to act as trustee – which may not always be possible.
4. How They Affect Medicaid Eligibility
Another key difference between these two types of trusts is how they can affect Medicaid eligibility.
With a revocable trust, the assets remain part of your estate – which may make them subject to Medicaid spend down requirements if you later need nursing home care and want access to Medicaid benefits. However, conversely, a revocable trust can also provide some protections against the financial and legal costs that might be incurred if you are sued for medical malpractice.
An irrevocable trust does not count towards Medicaid eligibility – and in fact, it may even allow you to qualify for this type of assistance sooner than if you didn’t have a trust at all. That’s because an irrevocable trust is treated like any other asset when determining whether someone is eligible for benefits; however, they’re not considered part of your estate, so they don’t count towards the Medicaid spend down requirements.
5. How Long They Last
Another key difference between these two types of trusts has to do with how long they last. A revocable trust typically ends upon the grantor’s death; however, a trust that is set up as part of an estate plan can also include a clause designating when it will end – for instance, if all named beneficiaries are deceased or reach a certain age, at which point its assets will be distributed among heirs according to the terms of your will. An irrevocable trust may also have this type of clause built into it – but in general, it lasts longer than a revocable one does, and it does not terminate upon the death of the grantor. This is because the assets are no longer technically part of your estate once they’re transferred to this type of trust, and thus aren’t subject to probate or its associated costs.
A revocable trust may also include a clause that keeps it in existence as long as you live – at which point its assets will be transferred to your heirs according to the terms of your will. It can also designate a time period for when it should be terminated, and may do so automatically if key criteria have not been met by a specified date. In general, however, an irrevocable trust does not end until the named beneficiary receives all the funds within it; most trusts specify that the remainder will be transferred to a charity if the beneficiary dies before receiving all of its assets
6. How They’re Taxed
Another important difference between these two types of trusts has to do with how they’re taxed. A revocable trust is considered part of the grantor’s estate for tax purposes, and thus its assets are subject to estate taxes. This can be avoided by transferring the trust’s assets prior to your death – at which point they’ll count towards Medicaid eligibility requirements instead. However, if you later file an income tax return as though you were married filing jointly, any income earned on those funds will still need to be reported on your joint tax return alongside your spouse’s income; otherwise, it might not be treated as taxable property for federal income tax purposes.
An irrevocable trust does not count towards your estate for tax purposes, which can help to minimize the amount of taxes that your heirs will need to pay upon your death. However, any income earned by the trust is still considered taxable property, and thus must be reported on the trustee’s individual income tax return. Additionally, if the trust’s assets are ever distributed to its beneficiaries, they may be subject to gift taxes – although there are annual exclusion limits that apply in this case, so it’s important to consult with a tax professional before making any large transfers.
7. How They’re Used in Estate Planning
Finally, it’s worth noting that these two types of trusts are often used differently in estate planning. A revocable trust can be used to manage assets during your lifetime, and can also be used to transfer property to heirs after your death. An irrevocable trust, on the other hand, is typically used for asset protection purposes – for instance, if you’re concerned about the possibility of creditors seizing your assets in the event that you’re sued. It can also be used to minimize estate taxes, or to set aside funds for special needs beneficiaries without affecting their eligibility for government benefits.
In general, revocable trusts are more flexible than irrevocable trusts – but that doesn’t mean that one is necessarily better than the other. The type of trust that’s right for you will depend on your specific goals and circumstances; thus, it’s important to consult with an experienced estate planning advisor or attorney before setting one up.
The right type of trust for your estate plan will depend on your unique situation, goals, and financial resources. By working with an experienced professional, you can make sure that your wishes are carried out and your beneficiaries protected in the way that’s best for everyone involved.