The Rockefellers may be one of the wealthiest families to use trust to pass on and protect their wealth, but despite what you’ve been led to believe, trusts aren’t only for the ultra-wealthy. If you are curious about how trust works, how it could benefit you, your family, and your business, and the difference between revocable vs. irrevocable trust, read on to get an inside scoop and make an informed decision.
Introduction To Trusts
Before we get into the deep end of the difference between a revocable vs. an irrevocable trust, let’s talk about trusts. A trust is generally created by writing and signing a trust agreement, which is a legally binding document.
A trust is a legal entity through which assets such as real estate, cash, and other investments can be invested, protected, and controlled to provide for specific people or causes you to care about with certain conditions and guidelines that are established by the grantor (the person setting up the trust and generally contributes assets to create the trust in the first place). In sum, a trust holds property and assets in a fiduciary relationship by one party for the benefit of another party.
Trusts have a long history as a tool for people to protect their assets and control how they are transferred to others. The simplest idea behind the concept of trust is two connecting dots- protection and long-term planning. Underlying the need to protect and control, you’ll also discover that tax issues are a reason for the popular use of trusts.
Now, you understand the basics of trust, but you must be stuck between which type to choose. Which kind of trust is suitable for you and your personal needs? Let’s talk about the difference between revocable vs. irrevocable trust.
What Is A Revocable Trust?
A revocable trust, also called a living trust, is a flexible planning tool that allows you to retain control of your assets during your lifetime. A revocable trust fund gives a grantor better control over assets during the grantor’s lifetime. Once an asset is placed in a revocable trust, it can be transferred to any chosen beneficiary after a grantor’s death.
The revocable trust offers a rainbow of benefits, including the fact that it can be amended and changed at any given time during your lifetime. While you might find this very appealing if you value flexibility, it’s important to understand that the revocable trust has no tax benefit.
What Is An Irrevocable Trust?
An irrevocable trust is a trust that cannot be amended, changed, or terminated easily once it’s signed. Only a few rare, isolated instances would allow modifications for an irrevocable trust, and generally must be approved through the permission and consent of all named beneficiaries. However, because of its rigid nature, an irrevocable trust may be more complicated to set up than a revocable trust.
The Difference Between Revocable Vs. Irrevocable Trust
A lot of people get caught in the middle when trying to make a decision about which trust to choose. A closer look at the major differences can help you make a better decision here:
Trust Modification
For either of the two types of trusts, until the trust documents are created and signed by the owners, there is no trust. However, the primary difference between revocable vs. irrevocable trust is whether the trust can be modified or not after its creation and execution.
For a revocable trust, the document is worded in a language that allows for alterations, modification, and even revocation. In other words, if you choose the revocable trust, you can change your mind about keeping the trust or revoking it.
On the other hand, an irrevocable trust is iron-clad. Once it is signed, witnessed, notarized, and funded by having assets placed in it, it can’t be reversed by the trustee or the individual who created it. The language in an irrevocable trust is so concrete that it is nearly impossible to reverse after it becomes effective, even if you change your mind later.
Asset Protection
Another key difference between revocable vs. irrevocable trust is the protection of assets. When it comes to asset protection, an irrevocable trust is far more beneficial than a revocable trust. The reason is that if a trust is revocable, the person who created the trust reserves complete control over all trust assets, including the right to transfer property out of the trust whenever the person desires. In simple terms, it is still considered part of the grantor’s estate and, therefore, subject to the creditor’s claims.
In contrast, once an irrevocable trust is created and assets are transferred, whether they are cash or property, your creditors usually cannot attach or execute against the property in the trust. This means your trust is protected from credit and legal judgments.
Property Ownership
Property ownership is another difference between revocable vs. irrevocable trust. Although a person becomes the owner of assets and property once they are transferred into the trust, but because the trust is revocable, ownership can be changed at any time. Therefore, the law considers that the creator of a trust will continue to maintain ownership or control over the assets, including the power to revoke it.
The case is not the same for an irrevocable trust. Once trust properties such as vehicles, land, bank accounts, and any other type of asset are transferred into the trust, the trust becomes the property owner. In sum, the person who previously owned the assets no longer has control over the property once it is transferred to a trust.
Taxes
Another difference between revocable vs. irrevocable trust is the federal estate taxes. Generally, a married couple can enjoy a federal estate tax exemption if their estate is less than $22 million. Couples with estates valued larger than this may find a trust a helpful estate planning tool to protect their estate from taxes.
The flexible nature of a revocable trust means it cannot be used to avoid federal estate tax on an estate worth more than $22 million because it is still under your ownership. However, an irrevocable trust can fulfill this purpose because property transferred to an irrevocable trust does not count towards the gross value of an estate, which can help reduce your estate tax liability if you have a large estate worth over $22 million.
In addition, since irrevocable trusts remove the benefactor’s taxable estate asset, they won’t be subject to tax upon death or bear any tax liability for any income generated by the asset.
Take Home
Setting up a trust fund can be complicated, but one of the things that makes it easier is determining which trust best fits your needs. If your estate plan is straightforward and you prefer a flexible trust, you can choose to create a revocable trust, but if you are looking for something to protect your estate from taxes and protect your assets from the risks of lawsuits, an irrevocable trust could be helpful. Ensure you consult an attorney to get the benefits and understand the difference between revocable vs irrevocable trusts.
