Trusts come in different forms but there are two major classification or types of trusts. A trust could either be revocable or irrevocable. As the name implies, the former can be changed or terminated by the creator during his lifetime, while the latter cannot. For this single difference, most clients tend to opt for the revocable trust as they wouldn’t want to create something which they have no power to change or control. But is this all the difference between the two? Is a revocable trust always more preferable than an irrevocable one? To answer that, we need to have an in-depth knowledge about these two.
As the name suggests, an irrevocable trust is a type of trust which can never be changed, altered or terminated by the creator once it has been created. Unless for a few occasions – very rare – irrevocable trusts hold forever.
Once funded with assets, an irrevocable trust takes full ownership of such assets. It therefore means that the grantor or trustor (creator of the trust) has lost ownership of those assets. The grantor can never take property or funds away from an irrevocable trust until death, neither can he or she be a trustee to the trust. Before creating an irrevocable trust, one should be ready to let go of those assets.
It is important to contact a highly experienced trust lawyer to guide you before writing your terms of trust as they would be forever binding.
A revocable living trust becomes irrevocable at the moment the grantor dies as the trust ceases to be alterable.
Despite the above shortcomings of irrevocable trusts, they can be used to achieve certain important estate planning goals explained below:
When property is transferred into an irrevocable trust, the value of the property is removed from the grantor’s estate and therefore, that property will not be taxed when the person dies since it is not in the person’s name but that of the trust.
Assets placed into an irrevocable trust will be managed by the designated trustee and will pass outside of probate to the beneficiaries. Since these assets are no longer part of the estate, they will not be subject to estate taxes.
Qualifying for government assistance
There is a threshold limit when qualifying for Medicaid and other government benefits. When your estate exceeds this amount, you will not qualify. If this applies to you, instead of spending down your assets, simply transfer some assets into an irrevocable trust until your estate values below that amount. Since those assets have left your possession, they will not be counted against you.
This works just the same way as tax avoidance. By transferring your assets into an irrevocable trust, you give up ownership and access to the trust assets, thus putting them out of reach of your creditors. The assets are thus protected from your creditors.
Revocable trusts have an advantage over irrevocable trust in that the terms of trust can be changed or annulled at anytime. A revocable trust avoids probate just like an irrevocable trust. The assets transferred into a revocable trust can be removed by the grantor at anytime as he or she desires.
The revocability of a trust has a downside: since the trust assets can be taken back into the ownership of the grantor at anytime, those assets would still be seen as the property of the grantor and as such, taxes would be imposed on those assets — since they are still a part of his or her estate — before they can be passed on to beneficiaries.
Most living trusts are revocable trusts. A revocable living trust is preferable for clients who wish to plan for mental incapacity or any other terminal illness that could suddenly arise during old age. When the grantor becomes incapacitated, the designated trustee steps in to handle the grantor’s personal and estate affairs according to the instructions laid down by the grantor.
As can be seen, irrevocable trusts have more long-term financial advantages over revocable trusts. Irrevocable trusts are better suited for those who wish to significantly cut down or avoid estate taxes, while revocable trusts are better suited for those who fear incapacity and hence wish to protect their assets should they become incapable of handling their affairs themselves. The appointed trustee manages the trust assets until the death of the grantor, after which they will be passed on to the designated heirs.