Revocable vs. Irrevocable Living Trusts
To Change or Not to Change a Trust
Trusts come in all shapes and sizes, and many are formed with a specific purpose or goal in mind. A "living" trust is one that the trustmaker or grantor—the individual who creates and funds the trust—sets up while she's alive. These are also sometimes called "inter vivos" trusts.
All living trusts are either revocable or irrevocable.
Revocable Living Trusts
A revocable living trust is a type of trust that can be changed at any time. If you have second thoughts about a provision in the trust or if you change your mind about who should be a beneficiary, you can modify the trust's terms with a trust amendment. You can revoke or undo the entire trust if you decide that it just doesn't serve your purposes any longer.
So why aren't all trusts revocable if these trusts are so flexible? Because all assets transferred to the trust are still considered your own personal assets as far as creditors and estate taxes are concerned.
A revocable trust offers no creditor protection if you're sued. The trust assets are considered to be owned by you for Medicaid planning purposes, and all assets held in the name of the trust at the time of your death might be subject to both state estate taxes and federal estate taxes.
The law takes the position that if you can undo or change the trust at any time, you still own the assets.
What Can a Revocable Trust Do?
A revocable trust allows you to plan for mental disability. Assets held in the name of a revocable living trust at the time the grantor becomes mentally incapacitated can be managed by a successor trustee, someone the grantor names to take over in the event he can no longer manage the trust himself.
Revocable trusts also avoid probate of the assets they hold. These assets will pass directly to the beneficiaries named in the trust agreement. There's no need for probate court involvement.
A revocable trust can protect the privacy of your property and beneficiaries when you die as well. Because it's not subject to probate, your trust agreement remains a private document. It doesn't become a public record for all the world to see. Your assets and who you've decided to leave your estate to will remain a private family matter.
Contrast this with a last will and testament that has been admitted for probate. It becomes a public record that anyone can see and read as soon as it's submitted to the court.
An irrevocable trust is simply a type of trust that can't be changed by the grantor after the agreement has been signed and the trust has been formed and funded. For the most part, it's forever. You can't take property back that you've placed into it. You can't act as trustee and manage the trust's assets. You form the trust and step aside for all time.
A revocable living trust becomes irrevocable when the grantor dies because he's no longer available to make changes to it. But a revocable trust can be designed to break into separate irrevocable trusts at the time of the grantor's death for the benefit of children or other beneficiaries.
Irrevocable trusts can take on many forms and can be used to accomplish a variety of estate planning goals.
Estate Tax Reduction
Irrevocable trusts, such as irrevocable life insurance trusts, are commonly used to remove the value of property from a person’s estate so that property can't be taxed when the person dies.
In other words, the person who transfers assets into an irrevocable trust is permanently giving those assets to the trustee and the beneficiaries of the trust. She no longer owns the assets. If she no longer owns the assets, they don't comprise or contribute to the value of her estate. They're not subject to estate taxes when she dies.
An AB trust is created for the benefit of a surviving spouse and it's also irrevocable. It can make full use of the deceased spouse's exemption from estate taxes through the funding of the B part of the trust at the time of death with property valued at or below the estate tax exemption.
Then, if the value of the deceased spouse's estate exceeds the estate tax exemption, the A Trust will be funded for the benefit of the surviving spouse and payment of estate taxes will be deferred until after the surviving spouse dies.
For example, the state estate tax exemption is only $1 million in Massachusetts as of 2018, compared with the federal $11.18 million exemption in the same year. The first $1 million of an estate would go into the B Trust, the next $10.18 million would go into the C trust, and anything over the total of $11.18 million would go into the A Trust.
Asset Protection Trusts
Another common use for an irrevocable trust is to provide asset protection for the grantor and his family. This works in the same way that an irrevocable trust can be used to reduce estate taxes.
By placing assets into an irrevocable trust, the grantor gives up complete control over and access to the trust assets. The assets therefore can't be reached by the grantor's creditors because he no longer owns them, and they're not an available resource for Medicaid planning, either.
But the grantor can name her family as beneficiaries of the irrevocable trust so she's still providing them—the assets are just outside of the reach of creditors.
Charitable Estate Planning Trusts
An irrevocable trust can accomplish charitable estate planning, such as through a charitable remainder trust or a charitable lead trust.
If the grantor makes the initial transfer of assets into a charitable trust while he's still alive, he can claim a charitable income tax deduction in the year the transfer is made. If the initial transfer of assets into a charitable trust doesn't occur until after the grantor's death, his estate will receive the charitable estate tax deduction instead.
Note: Trusts are governed by both state and federal law. These laws change periodically and you should always consult with a tax professional or an attorney for the most up-to-date advice. The information contained in this article is not intended as tax or estate planning advice, and it is not a substitute for such advice.