Differences Between Revocable and Irrevocable Trusts
and When Do You Need Them?
In planning their estates, people turn to
Revocable Trusts
- Manage clients affairs during incapacity better than powers of attorney alone
- Avoid Probate court at death, provided that the trusts are funded with all assets
- Protect Assets for their creators to a limited degree, and
- Save taxes, hassles, time and/or expense in settling their estate.
- Revocable Trusts help minimize estate taxes by creating Bypass Trusts
- Revocable Trusts are NOT useful to protect against the Grantors’ nursing home spending
- Revocable Trusts CANNOT save estate taxes in the estates of most single persons
- Revocable Trusts CANNOT protect the assets of the grantor from claims of his or her creditors or in divorce
Irrevocable Trusts
- Elders may want to shelter assets from nursing home costs using Irrevocable Income-only Trusts
- To save estate taxes and achieve Asset Protection, wealthier families commonly use:
- Irrevocable Life Insurance Trusts
- Charitable Remainder Trusts
- Spousal Lifetime Access Trusts
- Business owners and professionals may turn to Domestic Asset Protection Trusts for protection and income tax reduction.
- Ultra high net worth families may turn to other advanced tools like Qualified Personal Residence Trusts, Grantor Retained Annuity Trusts and Generation Skipping Trusts to reduce the size of their estates for tax purposes.
Special purpose trusts may or may not be irrevocable, such as Heirloom Ownership Trusts for vacation properties, and Supplemental Needs Trusts for disabled beneficiaries.
While revocable trusts can address some goals, irrevocable trusts are needed when strong asset protection is desired and advanced estate tax and income tax planning is desired.
The difference is best explained by the fact that what you put into a revocable trust (bank accounts, investments, real estate, business assets, etc.), you can take back or revoke, at any time. Whereas, what you put into an irrevocable trust, you cannot take back; you have made a transfer you cannot reverse – which is the basis of the tax and asset protection advantages you are looking for.
The terms of an irrevocable trust are largely set in stone. With some irrevocable trusts, you may be able exercise influence over the management of the trust, and you may be able to change who will receive the trust assets after you’re gone, but you will need to work through a trustee – who is not going to be you, in most cases. Maybe a trustee can distribute assets to you, in a small number of jurisdictions and instances.
Trust Protectors can be appointed to make changes in the terms of an irrevocable trust in order to comply with your wishes. Non-judicial settlement agreements among beneficiaries, judicial modifications or reformations, and transferring (decanting) to a new trust can also assist with keeping an irrevocable trust in compliance with your wishes and the best interests of the beneficiaries.
It is rare that a family will not benefit from a revocable trust. For example, avoiding Probate with a funded revocable trust is very effective. If the family also faces estate tax, then the trust can assist with that goal. Manage affairs? Check. Therefore, good estate planning starts with revocable trusts.
As age, wealth, and risks to assets change over time, families turn to Irrevocable Trusts. Irrevocable trusts can freeze the value of assets, lower estate and income tax burdens, protect assets and avoid gift taxes.
Real-World Case Study | Revocable Trusts
Penny and Jake are age 68 and are revising their estate plan. They have an estate of $2.5m and expect their assets to continue growing. They have 3 children (A, B, and C) and 6 grandchildren. When they wrote their last estate plan, all were seemingly healthy and at low risk for life issues. But now, 15 years later, Child A is healthy, has a good career and good savings, but has an unstable marriage. Child B struggles with addiction and gambling. Child C is a single parent and unable to pay for her kids’ college.
Jake and Penny want to Care for their loved ones, Anticipate their incapacity, Protect assets for their children, and Settle their estate with as little hassle and taxes as possible. These are very typical goals (and make up the acronym CAPS).
They sign health care proxies (powers of attorney for health care), financial durable powers of attorney, wills that “pour over” into their trust, and a revocable trust. The trust has a tax shelter for state estate tax savings. When the first of them dies, the deceased spouse’s portion will consist of a Bypass Trust and remain separate from the survivor’s estate and avoid estate tax.
The trust also has Inheritance Trust provisions for the children. A’s inheritance will be protected from being lost in the divorce. B’s portion will be in trust for life with an Independent Trustee in charge to guard against destructive spending habits. C’s share will be sheltered for the grandkids’ college costs and to secure C’s own retirement.
Real-World Case Study | Irrevocable Trusts
A few years later, Penny’s mother dies of Alzheimer’s and her sister is showing signs of the disease, and Jake’s single brother probably will leave him $10m when he dies. They still want CAPS (Care, Anticipate, Protect and Save), but they also want to Manage their affairs in their old age, Avoid Probate, Protect Assets for themselves as well as their children, and Saving taxes is more important than ever (MAPS).
Jake and Penny sign Irrevocable Trusts to protect their primary and vacation homes from long-term care costs (LAST Trust). They created an Irrevocable Life Insurance Trust (ILIT) to shelter a second-to-die life insurance policy and provide tax-free liquidity to pay any estate taxes.
They leave no stone unturned in funding their trusts with their attorney’s and financial advisor’s help to avoid Probate and be sure that their affairs will be managed in their final years. They plan ahead that, if Jake’s brother leaves him millions, they will create a Gift Trust to make transfers of the new wealth to their children, or partially Disclaim some of the inheritance.
They recommend to Jake’s brother that he create Inheritance Trusts™ in his estate plan – for Jake and his children, in case they inherit.
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