Trusts - Revocable v. Irrevocable: Which is “right” for you?
Revocable v. Irrevocable Trusts
Trusts can be powerful, effective estate planning tools. Trusts allow individuals to efficiently distribute their assets upon their death, and they give individuals the ability to determine how their assets are managed during the individual’s lifetime. There are two general types of trusts – revocable and irrevocable. (And, within those general distinctions, there are many “specialized” types of trusts that can be created. The purpose of this article is to give a broad overview of the two general types of trusts.) Revocable and irrevocable trusts serve different purposes and each offers unique advantages–and disadvantages. It is important to understand the benefits and limitations of each type of trust (and consult with an estate planning attorney) before choosing the best vehicle for your unique situation.
Revocable Trusts
A revocable trust is one that the grantor – the individual creating the trust – can modify or terminate at any point during the grantor’s lifetime. In a revocable trust, the grantor retains ownership and control of his or her assets after the assets are placed into the trust. In this form of trust, the grantor can be both the trustee (the person who manages the assets) and the beneficiary (the person who benefits from the trust) of the trust.
Advantages of a Revocable Trust
1. Avoid Probate: Although probate does not have to be the horror show that many fear it could be, it can be a lengthy process and a public one (the decedent’s will and the court proceedings become part of the public record). Assets properly placed into a revocable trust generally avoid probate. This helps keep the decedent’s assets private and allows them to be distributed to the decedent’s beneficiaries more rapidly.
2. Flexibility: A revocable trust can be amended as many times as the grantor wishes over the course of the grantor’s lifetime. Assets can be added to or removed from the trust; the grantor can change beneficiaries or the percentages allotted to beneficiaries; the grantor can even change the terms that govern how and when beneficiaries may receive distributions. In other words, the grantor retains a great deal of control over the trust assets even though the assets are in trust.
3. Privacy: This goes hand-in-hand with the avoiding probate advantage, but trusts offer a level of privacy to the grantor that he or she would not otherwise enjoy. If the grantor instead died without a trust, his or her assets would have to go through probate or administration proceeding in Surrogate’s Court. Most of the filings in those proceedings are public record.
4. Incapacity Planning: If the grantor becomes incapacitated, a successor trustee can step in to manage the grantor’s assets that are held in trust. The successor trustee would be able to step in without court intervention, which helps ensure continuity of asset management and provides less stress to the family of the grantor.
Limitations of a Revocable Trust
1. No Asset Protection: This is the big limitation of a revocable trust – a revocable trust will not (usually) protect your assets from legal claims or creditors. It also will not “remove” your assets from estate to help qualify you for Medicaid. Because the grantor retains control over the trust assets, the assets are deemed available to creditors.
2. Tax Liability: Because the grantor retains control over the trust assets, any income generated by the trust is usually taxable to the grantor. A revocable trust also does not remove the assets from the grantor’s estate, so the estate may be liable for estate taxes if the assets exceed the estate tax threshold.
3. Cost: Creating and funding a revocable trust is more expensive than creating a Will.
Irrevocable Trusts
An Irrevocable Trust is a trust that can not be modified or terminated unless the beneficiaries all agree to do so. In other words, the grantor does not have unilateral control over the trust’s assets, or, in many cases, the grantor relinquishes all control over the assets placed into the trust. In an Irrevocable Trust, the grantor transfers all ownership and control of the assets to a trustee, and the grantor (typically) can not serve as the trustee. Irrevocable trusts are useful in that they can offer the grantor true asset protection, tax benefits, and Medicaid or long term health planning, but they do come with limitations/disadvantages in return for those advantages.
Advantages of an Irrevocable Trust
1. Asset Protection: Asset protection is a large draw for grantors who wish to protect their assets from creditors and legal claims. In an irrevocable trust, because the grantor has relinquished control of the assets placed into the trust, the grantor’s creditors and claimants can not reach the trust’s assets.
2. Medicaid Planning: Irrevocable trusts can be used as part of a Medicaid planning strategy. (N.B.: The grantor’s individual circumstances must be carefully considered before utilizing an Irrevocable trust for this purpose.)
3. Tax Benefits: Some grantors’ estates have significant assets that could result in large tax consequences. Irrevocable trusts can be used to help reduce estate taxes in such instances. In other cases, irrevocable trusts can offer income tax benefits.
4. Gifting: Irrevocable trusts can be used to structure gifting of the grantor’s assets to beneficiaries over time, thereby reducing the grantor’s estate for tax purposes.
Limitations of an Irrevocable Trust
1. Loss of Control: A grantor will lose control of the assets placed into an irrevocable trust. Generally, an irrevocable trust can not be altered or revoked without the express consent of all beneficiaries. For that reason, the grantor must choose a trustee he or she truly trusts and select responsible successor trustees. It may also be warranted to have a trust protector named, which adds to the complexity of the irrevocable trust and thereby increases its costs, but which may allow the grantor greater peace of mind as he or she relinquishes control of assets to the trust.
2. Tax Implications: Because the grantor relinquishes control of assets to the trust, the grantor is not typically taxed personally on the trust. Rather, the trust itself is required to file its own tax returns. Trusts follow the same brackets as do individuals for taxes, but the brackets are compressed such that trusts reach the higher brackets at a lower income level. As a result, the tax liabilities for an irrevocable trust may be quite high. Trust beneficiaries may also incur tax obligations when they receive distributions.
3. Complexity: Irrevocable trusts, for all the reasons stated above, are often more complex to create and administer as compared to a revocable trust.
How do I choose between a revocable and an irrevocable trust?
There is no “one size fits all” answer to estate planning. Every client’s goals and portfolio is unique. Some clients are perfectly served by a Will (no rush to administer assets, small portfolio, no estate tax liablities). Other clients are more comfortable with the privacy and expediency of a trust. If a trust sounds like a better vehicle for you, we encourage you to consider the costs to establish, fund, and administer the trust; tax implications; flexibility to modify your trust; protection from creditors; medicaid or long term health planning; and comfort with relinquishing control of your assets (and to meet with us) before determining whether a revocable or irrevocable trust is best for your circumstances.
Seward & Seward helps clients of all means – those with modest assets and those with substantial assets – plan their estates and has done so for over 50 years. After carefully discussing your goals and assets with you, we will work with you to craft a customized plan that suits your needs. Please call or email us today to set up an appointment.