Revocable vs. Irrevocable Trusts

Which Type of Trust is Best for You?

Revocable vs. Irrevocable Trusts
February 13, 2016

Thinking about setting up a trust for your family? Human nature being what it is, you might want to keep your options open by setting up a trust that you can change or cancel at any time. If your formerly sweet granddaughter tells you she is devoting her life to Satan worship, for example, you might want to reconsider leaving her a small fortune with which she can further her dubious goals. However, there are major differences between setting up a revocable trust and an irrevocable trust.

First, the basics: if you set up an irrevocable trust, you cannot change your mind later on. With a revocable trust, you still control the assets, and can change the terms or revoke the trust entirely.

Don't confuse this with living or testamentary trusts – that only refers to whether the trust takes effect during your life or upon your death, respectively. Living trusts can be either revocable or irrevocable up until your death, when both you and your trust become irrevocable, so to speak. Testamentary trusts are by definition irrevocable, unless you can figure out how to revoke death to make changes to the trust. (If you do, please let us know!)

Let's take a closer look at the two styles.

  • Revocable Trust – The main reason for this type of trust is to bypass the probate process upon your death. Assets will pass directly to all of the beneficiaries listed in the trust.

    Other reasons are to appoint someone to manage your affairs if you are still living but mentally incapacitated, or for privacy reasons – unlike probate, which is a court procedure with a public record, the details of your assets and beneficiaries are spared from public scrutiny.

    Revocable trusts can be changed at any time, or revoked entirely. The downside of this control is the corresponding lack of tax benefits. The assets are still considered yours and thus are still subject to income and estate taxes, and are not protected from creditors.
  • Irrevocable Trust – In this case, you are giving up all rights and ownership to any of the assets in the trust. The upside of no longer owning the assets is that you cannot be taxed for the income that they generate – the taxes are applied to the trust. This is one reason you generally cannot be both the grantor and the trustee.

    The two primary reasons to set up an irrevocable trust are to lower your taxes, and to protect property. This generally is only for significantly wealthy families who can afford to part with significant assets in order to pass them on tax-free.
  • Examples include: o Bypass trusts, where you bypass the estate tax by diverting some assets into the trust and passing the remainder tax-free to your spouse upon your death;
    • Life insurance trusts, which passes policy money to your beneficiaries tax-free;
    • Generation-skipping trusts that pass wealth to your grandchildren;
    • Charitable trusts that reduce your taxable income and estate taxes through gifts to charity.

Both kinds of trusts can hold a variety of assets, such as stocks and bonds, a business, life insurance, or cash.

To determine which type is right for you, consider the following:

  • Plans – Are you trying to protect specific assets, and is there a specific irrevocable trust designed for that purpose? If your only purpose is to avoid probate, a living trust probably makes more sense.
  • Taxes – Are you trying to avoid or minimize taxes? If so, a form of irrevocable trust is best.
  • Overall Financial Situation – Do you have enough assets that you can afford to give substantial portions of it away just to avoid taxes? If not, you probably need a living trust.

With these issues in mind, you should be able to pick the type of trust that fits your situation best, and you can then relax, with the peace of mind that a trust can provide. That gives you plenty of time to work on whatever you choose. Please let us know how that death revocation project is going!

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