What's the Difference Between a Revocable Trust and an Irrevocable Trust?
Revocable Living Trusts
A revocable living trust, also known as a revocable trust, living trust or inter vivos trust, is simply a type of trust that can be changed at any time.
In other words, if you have second thoughts about a provision in the trust or change your mind about who should be a beneficiary or trustee of the trust, then you can modify the terms of the trust through what is called a trust amendment. Or, if you decide that you don't like anything about the trust at all, then you can either revoke the entire agreement or change the entire contents through a trust amendment and restatement.
Since revocable living trusts are so flexible, why aren’t all trusts revocable? The downside to a revocable trust is that assets funded into the trust will still be considered your own personal assets for reditor and estate tax purposes. This means that a revocable trust offers no creditor protection if you are sued, all of the trust assets will be considered yours for Medicaid planning purposes, and all assets held in the name of the trust at the time of your death will be subject to both state estate taxes and federal estate taxes and state inheritance taxes.
So why should you use a revocable living trust as part of your estate plan? For three important reasons:
To plan for mental disability - Assets held in the name of a Revocable Living Trust at the time a person becomes mentally incapacitated can be managed by their disability trustee instead of by a court-supervised guardian or conservator.
To avoid probate - Assets held in the name of a Revocable Living Trust at the time of a person’s death will pass directly to the beneficiaries named in the trust agreement and outside of the probate process.
To protect the privacy of your property and beneficiaries after you die - By avoiding probate with a revocable living trust, your trust agreement will remain a private document and avoid becoming a public record for all the world to see and read. It will keep the details about your assets and who you have decided to leave your estate to a private family matter. Contrast this with a last will and testament that has been admitted to probate - it becomes a public court record that anyone can see and read.
An irrevocable trust is simply a type of trust that can't be changed after the agreement has been signed, or a revocable trust that by its design becomes irrevocable after the Trustmaker dies or after some other specific point in time. However, refer to Can an Irrevocable Trust Be Changed? for additional information about certain situations in which an irrevocable trust may be changed.
With the typical revocable living trust, it will become irrevocable when the Trustmaker dies and can be designed to break into separate irrevocable trusts for the benefit of a surviving spouse, such as with the use of AB Trusts or ABC Trusts, or into multiple irrevocable lifetime trusts for the benefit of children or other beneficiaries.
Irrevocable trusts can take on many forms and 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 the property can't be taxed when the person dies. In other words, the person who transfers assets into an irrevocable trust is giving over those assets to the trustee and beneficiaries of the trust so that the person no longer owns the assets. Thus, if the person no longer owns the assets, then they can't be taxed when the person later dies.
As mentioned above, AB trusts that are created for the benefit of a surviving spouse are irrevocable and, thus, can make full use of the deceased spouse's exemption from estate taxes through the funding of the B trust 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.
Another common use for an irrevocable trust is to provide asset protection for the Trustmaker and the Trustmaker's 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 Trustmaker is giving up complete control over, and access to, the trust assets and, therefore, the trust assets cannot be reached by a creditor of the Trustmaker or an available resource for Medicaid planning. However, the Trustmaker's family can be the beneficiaries of the irrevocable trust, thereby still providing the family with financial support, but outside of the reach of creditors. There are also irrevocable trusts called self-settled trusts, or domestic asset protection trusts that in some states, including Alaska, Delaware, Nevada, and Tennessee, offer creditor protection and allow the Trustmaker to be a trust beneficiary.
Also, as mentioned above, the various irrevocable trusts that can be created for the benefit of the Trustmaker's surviving spouse or other beneficiaries after the Trustmaker of a Revocable Living Trust dies can be designed to offer asset protection for the trust beneficiaries.
Charitable Estate Planning
Another common use of an irrevocable trust is to accomplish charitable estate planning, such as through a charitable remainder trust or a charitable lead trust. If the Trustmaker makes the initial transfer of assets into a charitable trust while still alive, then the Trustmaker will receive a charitable income tax deduction in the year of the transfer is made. Or, if the initial transfer of assets into a charitable trust doesn't occur until after the Trustmaker's death, then the Trustmaker’s estate will receive a charitable estate tax deduction.