Revocable Trusts and Irrevocable Trusts – What’s the Difference?
Like a will, a trust is an estate planning tool that determines what happens to assets at death. Different from wills, however, trusts go through all the phases of your life and at death can provide strategies to reduce taxes and to avoid probate. The revocable trust and the irrevocable trust are the two basic types of trusts, although there are more.
A trust is a legal entity that a person, usually called a grantor or settlor, establishes during their lifetime to hold their assets. The trust agreement includes the grantor’s instructions for how the assets should be managed by the trustee during their incapacity and upon their death. Once the trust is funded—meaning the grantor’s assets are placed into trust—the trustee manages them according to the grantor’s instructions provided in the trust agreement.
The Revocable Trust
The grantor can amend and update to current law a revocable trust, sometimes aptly called a living trust, even after it is established. For example, the grantor can remove beneficiaries, add new beneficiaries, and change the instructions to the trustee who manages the trust assets. In the case of a revocable trust, the grantor is allowed to, and should, serve as the initial trustee. The Grantor appoints a successor trustee to take over managing the trust after the grantor’s incapacity and/or death.
The potential pros to using a revocable trust:
For young beneficiaries of a revocable trust, assets held within a trust can replace the need for a conservator if the grantor dies before the age of their majority. In addition, the revocable trust can set aside a specific amount to be distributed over time for a spendthrift beneficiary who might not manage the money responsibly. If legacy planning is one of your estate planning goals, you can set up a legacy trust for your beneficiaries to provide asset protection for them from divorce, bankruptcy, and other creditor issues. Most importantly, revocable trusts offer ongoing flexibility during the grantor’s lifetime. In addition, they tend to be easier to set up than irrevocable trusts.
The potential drawbacks to using a revocable trust:
As the grantor keeps control over a revocable trust, the assets are not protected from creditors as they would be in an irrevocable trust. In short, if the grantor loses a lawsuit, the court can order that the assets in a revocable trust be used to satisfy a judgment against the grantor.
The Irrevocable Trust
As the name suggests, the grantor cannot change the terms of an irrevocable trust after signing the trust agreement. In extremely rare circumstances, and only when permitted by state law, an irrevocable trust’s provisions may be changed by a court order and/or by the consent of all the trust beneficiaries. The grantor cannot be the trustee of an irrevocable trust. In sum, the grantor gives up full control of the assets in an irrevocable trust.
The potential pros of using an irrevocable trust:
The grantor relinquishing control over the irrevocable trust provides important advantages when it comes to taxes and asset protection. In terms of taxes, assets in an irrevocable trust are not subject to estate tax when the grantor dies. Additionally, the grantor has no tax responsibility for any income the assets may generate during the grantor’s lifetime. When it comes to asset protection, the assets in an irrevocable trust are protected from creditors, including judgment creditors.
The potential drawbacks to using an irrevocable trust:
Again, the downside to using an irrevocable trust is that the grantor may not make any changes once the trust agreement is signed. Further, because it cannot be altered, creating an irrevocable trust can be more time consuming and therefore more costly to establish than a revocable trust. In addition, any assets put into any irrevocable trust are no longer under the control of the grantor.
Contact a Virginia Estate Planning Attorney
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