Living trusts are popular tools in the estate planning process. There are two kinds of living trusts—revocable and irrevocable. When deciding what type of living trust will work best for your particular circumstances, it's important to understand the differences between a revocable and irrevocable trust.
We'll discuss some of the advantages and disadvantages associated with revocable and irrevocable trusts in terms of the probate process, estate taxes, privacy, and more.
What is a living trust?
A living trust is a trust that you create during your lifetime. The purpose of a living trust is to hold your assets while you're alive and distribute them according to your wishes at your death. As the trust owner, you can transfer all kinds of assets into your living will, including real estate, bank accounts, family heirlooms, and more.
A living trust differs from a will in that it doesn't go through probate. Since it doesn’t go through probate court, the trust doesn’t become part of the public record.
A living trust can be a revocable or irrevocable trust, with each having its own advantages.
What is a revocable trust?
A revocable trust is a living trust that you can revoke, amend, or cancel at any time. However, the term "revocable" includes more than just the ability to terminate the trust. The revocable living trust is a comprehensive estate plan that also lets you retain control over your assets, even though it's the trust that owns them. A revocable trust provides you with the flexibility to make changes to it whenever you want.
However, once the grantor dies, the revocable trust automatically becomes an irrevocable trust, meaning the conditions cannot be altered.
As the grantor of a revocable living trust, you can:
- Modify any of the trust terms
- Transfer assets in and out of the trust
- Reclaim property or spend money from the trust
- Change or remove beneficiaries, trustee, and successor trustee
- Revoke the trust at any time
Can you be your own trustee? Yes, many people designate themselves as their own trustees when they're setting up a revocable living trust. This allows them to maintain control until their death or if they become incapacitated.
Other advantages of a revocable living trust include the following:
- Avoiding probate. Because the trust owns the assets contained in the trust, these revocable trust assets aren't subject to the probate process on your death. This means your assets are available for distribution, and your named beneficiaries can avoid the lengthy and often costly probate court process.
- Maximizing privacy. Assets going through the probate process are a matter of public record. By keeping your assets within the revocable trust, you retain privacy over those assets and their manner of distribution.
- Your incapacitation. With a living trust, you can designate someone to step in if you become incapacitated, either mentally or physically, and can no longer manage the trust. Known as a successor trustee, they will oversee your trust and manage your assets, preventing the court from getting involved.
That said, it's important to note that a revocable trust does not offer asset protection. This means your assets are fair game to creditors, debt collectors, and plaintiffs in a lawsuit. Furthermore, estate taxes are associated with this kind of legal entity. In other words, you cannot sidestep estate taxes with this option, meaning all the assets held in the trust are still subject to state and federal estate taxes upon your death. You can also create revocable living trusts that help to reduce estate taxes, such as a so-called “AB” Trust for married couples.
What is an irrevocable trust?
An irrevocable trust also functions as its name indicates. It's irrevocable, so once you've set up an irrevocable trust, you cannot terminate, cancel, or make any changes to the irrevocable trust.
Given its lack of flexibility, the irrevocable trust isn't as popular within the estate planning process. Its irrevocability is its main disadvantage—once you transfer assets to the trust, you no longer control those assets.
There are, however, certain circumstances where an irrevocable trust might make sense, including the following situations:
- Minimization of estate taxes. Certain types of irrevocable trusts can help you to reduce or eliminate estate taxes. In some cases, you can avoid estate taxes because your assets may not be considered part of your estate when you transfer them to the irrevocable trust. The rules for these trusts can be complex, so it's always a good idea to consult with an estate planning attorney if your goal for your irrevocable trust is to minimize estate taxes.
- Medicaid eligibility. Government programs, such as Medicaid, often include specific thresholds that determine eligibility for the aid in question. By making your trust irrevocable, your beneficiaries are less likely to have their income or asset eligibility levels affected by the trust. The rules for Medicaid eligibility are complex and ever-changing, so be sure to consult with a professional.
- Creditor and lawsuit protection. Because it can't be terminated once it's set up, the irrevocable trust offers more creditor protection to both the settlor of the trust and the trust's beneficiaries than a revocable trust. This protection also applies to debt collectors and those who file lawsuits against the grantor. If creditor protection is one of your objectives, then you may want to consider an irrevocable trust.
- Avoiding probate court. Like revocable trusts, irrevocable trusts avoid probate, making it easier for your beneficiaries to receive your trust assets.
If we compare a revocable vs. irrevocable trust, a revocable trust tends to be less complicated and more straightforward than an irrevocable trust. The main differences are that revocable trusts provide more grantor control and flexibility but no asset protection and limited estate tax benefits, while irrevocable trusts offer limited grantor control and flexibility but more asset protection and potential tax advantages.
Important trust terminology
When drafting a living trust, it's essential to understand the terminology, as certain terms are common to all trusts.
- Grantor/settlor/trustor: The legal owner and creator of a trust.
- Trustee: The person who makes the decisions about the trust.
- Successor trustee: The person appointed to oversee the trust after the trustee can no longer act. They are often in charge of administering the trust and distributing the assets.
- Beneficiaries: The people to whom the assets of the trust will be distributed on your death.
- Estate tax: Government taxes imposed on inherited assets.
How to know which type of trust is right for you
Living trusts are important estate planning tools, but understanding them can be difficult, so we advise speaking with an estate planning lawyer or estate planner for assistance. They can help you determine which kind of trust best suits your circumstances and introduce you to other estate planning tools. At LegalZoom, we offer convenient estate plan services.
When meeting with an estate planning professional to decide on the best course of action, you'll need to consider your finances, businesses, and family structure, among other factors.
Finances
How much money you have and where that money is tied up could impact your estate planning. For example, estates of a certain size are subject to the federal estate tax, so you would want to select a living trust that offers the best tax advantages. The complexity of your financial situation could play a role in the decision, too.
Business
If you own a business, setting up a trust can help ensure your business stays intact. Your lawyer can help you determine which trust would most benefit the future of your business, protect it from certain creditors and lawsuits, and maximize tax exemptions.
Family
If you have a complex family structure, such as previous marriages or a blended family, you'll need to take special care when choosing a trust and drafting your estate plan. You'll want to choose a trust that provides the appropriate asset distribution for your chosen beneficiaries.
FAQs
Can I be the trustee of my own revocable trust?
Yes, in most cases, you can appoint yourself as the trustee of your revocable trust. However, you will need to select a successor trustee to take over that role when you die or become incapacitated.
What happens to a revocable trust after the grantor dies?
When a grantor dies, the revocable trust becomes an irrevocable trust, and the successor trustee appointed in the trust document will provide continuous management of the trust.
Do revocable trusts protect assets from creditors?
No, a revocable trust does not protect its assets from creditors, debt collectors, or plaintiffs in lawsuits. This means creditors can collect from revocable trusts.
That said, irrevocable trusts do provide creditor protection.
Do irrevocable trusts have to pay estate taxes?
It depends. The terms and conditions of irrevocable trusts can be complicated. However, in some cases, the trust assets are not subject to estate taxes and may qualify for a federal estate tax exemption. This is because your own assets are considered protected and separate from the estate, making them exempt from taxes.
How can an irrevocable trust be modified?
Although irrevocable trusts are not designed for modifications, there are ways of making changes. Usually, it requires all parties to agree on the changes and the submission of a consent modification document or trust amendment. However, in other cases, you may be able to request changes through the court.
Belle Wong, J.D., contributed to this article.