When deciding how to distribute assets to your heirs, consider setting up a trust as a part of your estate plan. There are two main types of trusts, revocable and irrevocable. It’s important to know how these trusts work so you can determine which arrangement works best for your goals. Here is a look at revocable vs. irrevocable trusts including their benefits and differences, to help you determine which is best for you.
What Is a Revocable Trust?
A revocable trust allows individuals to distribute assets to heirs during their lifetime. When discussing a trust, it helps to understand certain terms. The person who creates the trust is the grantor, the individuals who inherit the assets are the beneficiaries, and the person appointed to handle the trust on the grantor’s behalf is the trustee. The grantor always has the option to create a successor trustee to manage assets for beneficiaries. A revocable trust is established when a legal document is completed and signed, and assets are placed in the trust.
In a revocable trust, the grantor can change their mind at any time and dissolve the arrangement or modify the terms of the trust.
Benefits of a Revocable Trust
There are several main benefits of a revocable trust. They are as follows:
- Flexibility and control. The grantor can change or dissolve the trust at any time.
- Immediacy. Unlike a will, a trust document becomes effective once signed and funded. Heirs don’t have to wait until the grantor’s passing.
- Bypass probate. A trust can skip probate court, and heirs can inherit assets faster with minimal costs. In addition, because trust distribution is handled privately, the grantor can minimize potential claims on the estate from individuals who may think they have a claim to the assets.
Limitations of a Revocable Trust
Estate planning tools like a revocable trust also come with limitations. In the case of a revocable trust, there are two notable limitations.
- Minimal protection from creditors. Since the grantor of the estate owns the trust, creditors who are owed money can make claims against the assets.
- No real tax benefit. Since the grantor owns the assets, no real tax benefits apply to a revocable trust.
What Is an Irrevocable Trust?
An irrevocable trust works similarly to a revocable trust with a grantor, beneficiaries, and trustee. However, there is one key difference: the terms of the trust cannot be changed. There are a few exceptions to that rule, but generally, full consent is required by the beneficiaries or a court order. State laws also govern changing the terms of the trust.
There are different types of irrevocable trusts. The following are the more common types:
- special needs trust
- spendthrift trust
- bypass trust
- charitable trust
Benefits of an Irrevocable Trust
Like a revocable trust, an irrevocable trust has a unique set of benefits.
- Avoids probate. An irrevocable trust avoids the probate process and offers the same privacy as a revocable trust.
- Shelters assets From creditors. Since the terms of the irrevocable trust cannot change, the grantor no longer owns the assets. Creditors cannot place a claim on the assets in the trust.
- Estate tax benefit. Unlike a revocable trust, an irrevocable trust carries a tax benefit. Since the grantor permanently removes assets, the estate isn’t subject to a tax.
What Are the Limitations of an Irrevocable Trust?
Some of the limitations that individuals should consider before moving forward with an irrevocable trust are as follows:
- Little control. A grantor cannot modify terms in an irrevocable trust. As a result, the grantor loses the right to change their mind regarding the terms of the trust.
- No flexibility. If disagreements emerge with specific beneficiaries, the grantor cannot change the terms of the trust.
- Financial situations may change. Sometimes, because of a financial crisis, the grantor may need the assets they used to fund the trust. With an irrevocable trust, retrieving those assets becomes almost impossible.
- Complicated to set up. An irrevocable trust is generally difficult to manage since it has complicated strategies that can be hard to understand.
Revocable vs. Irrevocable Trust: Which Is Best for You?
Depending on your estate goals, one trust may be more beneficial than the other. It is always a good idea to consult a financial planner or estate planning attorney. When weighing a revocable vs. irrevocable trust, here are some of the factors you should consider:
- Flexibility and control. A revocable trust allows the grantor to change their mind and offers the ability to change the terms of the trust. An irrevocable trust doesn’t offer this same flexibility. For those whose estate planning and financial situation is in flux, it is likely better to put assets in a revocable trust.
- Asset protection. If asset protection ranks high on the grantor’s list, an irrevocable trust is a better option since it bars creditors from claiming a right to assets. In a revocable trust, assets are still subject to a creditor’s reach.
- Tax considerations. Evaluating your estate tax liability will be key in choosing an irrevocable or revocable trust. A revocable trust has very little tax benefit, while an irrevocable trust allows for tax planning and minimizing estate taxes.
Seniority is published by Finance of America Reverse LLC. The views expressed in this publication are those of the author alone and do not necessarily reflect the views and opinions of Finance of America Companies. This article is intended for general informational and educational purposes only and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.
