Revocable vs. Irrevocable Trusts

As its name suggests, an irrevocable trust cannot be terminated or substantially changed after it is created. In contrast, the terms of a revocable trust allow the grantor (or other qualified person) to end or change the trust.

In this article, we'll discuss the pros and cons of revocable and irrevocable trusts and how you can use them to meet your estate planning goals.

Revocable and Irrevocable Trusts - Key Similarities

From the highest view, all trusts, whether revocable or irrevocable, have certain features in common.

Every trust:

• is a legal entity (other types of legal entities are individuals or corporations)
• has a
• grantor that sets up the trust
• a trustee that manages trust property, and
• beneficiaries that benefit from the trust
• Is funded with trust property
• avoids probate
• keeps personal information private
• uses a written document to lay out its terms, and
• is signed by the grantors and acknowledged by a notary public.

Beyond that, trusts vary infinitely by having different goals, terms, and beneficiaries--and by being either revocable or irrevocable.

How Does a Revocable Trust Work?

Revocable trusts are a popular estate planning tool because you can change them at any time, and they don't affect your control over trust property.

To make a revocable trust, you:

• Create a trust document that names trustees and beneficiaries.
• Sign and notarize the document.
• Transfer property into the trust.

In most cases, while you are alive, you serve as the trustee of your trust, and you can revise it at any time. This gives you complete control over the trust and the property you transfer into it.

After you die, the trust becomes irrevocable, and the successor trustee you name in the trust takes over, distributing and managing trust property according to the terms of the trust. When the goals of the trust have been achieved (property distributed), the trust ends.

The type of revocable trust most commonly used in estate planning is a relatively simple "living trust" whose main goal is to distribute property and avoid probate after death.

Most revocable living trusts allow the successor trustee to step in and manage trust property if the grantor (and trustee) is ever unable to manage the trust, either temporarily or permanently. This feature provides an important safety during the trust maker's life.

Revocable trusts do not shield property from taxes or creditors. To do those things, you need an irrevocable trust. See below.

Types of Revocable Trusts

There are many types of revocable trusts, and they are generally categorized by their purpose. For example, the purpose of the revocable living trust described above is to avoid probate and distribute property, while the goal of a revocable pet trust is to provide care and financial support for your pet.

Here are short descriptions of some common types of revocable trusts:

Living trust. Individuals and families use this popular type of trust to distribute property and avoid probate.

Example: Charlie makes a revocable living trust to pass her property on to her nieces and to keep her estate out of probate. Until her death, Charlie is the trustee of the trust, and she can revise it at any time.

Shared living trust. A shared living trust is made by more than one person--usually a couple--that owns property together.

Example: Alex and Sam have been married for many years and co-own several together. They make a shared living trust to leave their co-owned and individually owned property to their children and other beneficiaries. During their lives, they are the trustees of the trust, and they can change or end the trust at any time.

Special needs trust (third-party). This type of trust is created by someone who wants to provide for a person with special needs. The trust protects the beneficiary's eligibility for government benefits and, if needed, it lays out specific instructions for how to use trust funds to care for the person. The trust cannot contain the beneficiary's own money, and the beneficiary cannot be the trustee.

Example: Jamie sets up a special needs trust for his nephew, who receives government disability benefits. Jaime serves as trustee and (following the terms of the trust) spends trust funds in a way that protects his nephew's eligibility for government benefits. When Jamie dies, the successor trustee Jamie named will take over managing trust property.

Pet trust. A pet trust is set up to benefit a person's pet. It describes how the pet should be cared for and provides funds to pay for that care.

Example: Laney sets up a pet trust for her cat. In the trust, she names herself as trustee, describes how trust funds should be used to care for her cat, and empowers a successor trustee to take over that care in case she dies or becomes incapacitated.

Sprinkling trust. A sprinkling trust provides for more than one beneficiary as a group, rather than individually.

Example: Jane wants to help her nieces pay for their education. She sets up a sprinkling trust that names her sister as trustee and gives the trustee the power to spend trust funds on education for the kids as needed. Jane's sister can spend different amounts on each child, depending on their individual needs.

Advantages of Revocable Trusts

• The grantor can change the terms of the trust or terminate it at any time.
• The grantor can retain control of trust property by naming themselves as trustee.
• Compared to irrevocable trusts, revocable trusts are often less complicated (and therefore less expensive) to set up.

Disadvantages of Revocable Trusts

• Revocable trusts do not shield property from creditors or taxes.
• Compared to wills, revocable trusts are a more complicated and expensive way to distribute property after you die.

How Does an Irrevocable Trust Work?

Usually, the key feature of an irrevocable trust is that the grantor cannot have any control or ownership of trust property. This separation of the grantor from trust property is what gives irrevocable trusts their function and power.

Types of Irrevocable Trusts

Irrevocable trusts tend to be categorized either by their purpose or by the way in which they shield property from taxes or creditors. Here are brief descriptions and examples of a few common types of irrevocable trusts.

Charitable trusts. Charitable trusts can be used to reduce estate and income tax.

Example: Mohammed wants to make sure that his $20,000,000 estate will not owe estate taxes when he dies. He creates a charitable trust and funds the trust with $6.5 million--just enough to get his estate under the estate tax exemption of $13.99 million. A trustee (not Mohammed) manages trust funds. Under the terms of the trust, Doctors Without Borders will receive income produced by the trust until Mohammed dies, at which point the $6.5 million will be divided among Mohammed's children.

First-party special needs trusts. Unlike third-party special needs trusts (described above), first-party special needs trusts contain property owned by the person who has special needs.

Example: Sarah received a $500,000 settlement for a slip-and-fall injury. As long as she has that money, she will not qualify for government disability benefits. Instead of spending down that money and then receiving benefits, she transfers the settlement money into a special needs trust. Sarah can now qualify for government benefits, and the trustee of the trust (not Sarah) can use the trust money to pay for very specific items to enhance her quality of life.

Medicaid trusts. A medicaid trust helps people to qualify for Medicaid while protecting assets for their beneficiaries.

Example: Apart from his primary home, Jerry's only significant asset is a lake house that he inherited from his parents. As long as he owns the lake house, he won't qualify for Medicaid. He transfers the lake house into an irrevocable trust. He no longer owns the house, and he'll be able to qualify for Medicaid after the "look-back" period. The trust names his children as beneficiaries of the house, so they will get it when Jerry dies.

Life insurance trusts. A life insurance trust keeps the value of your life insurance policy out of your taxable estate.

Trusts that reduce estate tax for couples. Several types of trusts can help couples reduce the possibility that their estates will owe federal estate taxes after they die. These include AB trusts, qualified terminable interest property (QTIP) trusts, and qualified domestic trusts (QDOT).

Advantages of Irrevocable Trust

The benefits of irrevocable trusts usually depend on their purpose, but generally, irrevocable trusts can be designed to:

• Avoid or reduce taxes.
• Shield property from creditors.
• Help you qualify for government benefits.
• Protect inter-generational family wealth.
• Stay true to the purpose of the trust after you die.

Disadvantages of Irrevocable Trusts

For those who need them, irrevocable trusts can be very useful. But they come with real downsides. Irrevocable trusts tend to:

• Be expensive to make and maintain.
• Require the trust maker to relinquish ownership of trust property.
• Be difficult to modify if your circumstances change.

FAQs

What type of trust is best?

Revocable trusts are best for people with average-sized estates who are mainly concerned with distributing their property and avoiding probate when they die. Irrevocable trusts are best for those with high-wealth who want to avoid income and estate taxes, those who need to shield assets in order to qualify for government benefits, or those who need to protect assets from creditors.

Can you spend money from an irrevocable trust?

This depends on the terms of the trust. Most often, the trust-maker cannot use the trust principal (the property used to fund the trust). However, depending on the purpose and terms of the trust, the trust maker may be able to use income generated from the principal.

Is a living trust revocable or irrevocable?

As commonly used, "living trust" almost always refers to a revocable trust. However, the full title of that type of trust is "revocable living trust." The "living" part refers to the fact that it takes effect during your life, as opposed to a testamentary trust that takes effect when you die. Therefore, it is certainly possible to have an "irrevocable living trust" -- an irrevocable trust that takes effect while you're alive--but that phrase is not commonly used in estate planning.

Are most family trusts revocable or irrevocable?

Family trusts can be revocable or irrevocable, depending on their purpose. For example, a trust can contain family property, benefit the family, be controlled and managed by the family, and be revocable. But if the family needs to protect or shield assets, then it would make an irrevocable trust. That trust could contain family assets and benefit the family, but technically, the family would not own the assets, and the trust would be controlled by a disinterested trustee.

What does it mean to revoke a trust?

Revoking a trust means that you take a trust that currently legally exists and make it not exist anymore.

What type of trust is best for grandchildren?

Whether you make a revocable or irrevocable trust for your grandchildren depends on whether or not you want to be able to change or revoke the trust while you're still alive. If you do, then you make a revocable trust. But if you need or want to shield the trust's assets from taxes or creditors, then you'd make an irrevocable trust.