Revocable Trust vs. Irrevocable Trust: An Overview
A revocable trust and living trust are separate terms that describe the same thing: a trust in which the terms can be changed at any time. An irrevocable trust describes a trust that cannot be modified after it is created without the consent of the beneficiaries.
A trust is a separate legal entity a person sets up to manage his assets. Trusts are set up during a person's lifetime to assure that assets are used in a way in which the person setting up the trust deems appropriate. Once assets are placed inside a trust, a third party, known as a trustee, manages them. The trustee determines how the assets are invested and to whom they are distributed when the owner of the trust dies, though a trustee must manage the trust in accordance with the guidelines laid out when the trust was formed. It is common for a wealthy person to use a trust as opposed to a will for estate planning and for stipulating what happens to his wealth upon his death. Trusts are also a way to reduce tax burdens and avoid assets going to probate.
Revocable Trust (Living Trust)
The two basic types of trusts are a revocable trust, also known as a revocable living trust or simply a living trust, and an irrevocable trust. The owner of a revocable trust may change its terms at any time. He or she can remove beneficiaries, designate new ones, and modify stipulations as to how assets within the trust are managed.
Given the flexibility of revocable or living trusts in contrast with the rigidity of an irrevocable trust, it seems all trusts should be revocable. The reason they are not is that revocable trusts come with a few key disadvantages.
Because the owner retains such a level of control over a revocable trust, the assets he or she put into it are not shielded from creditors the way they are in an irrevocable trust. If he or she is sued, the trust assets can be ordered liquidated to satisfy any judgment put forth. When the owner of a revocable trust dies, the assets held in trust are also subject to both state and federal estate taxes.
The terms of an irrevocable trust, in contrast, are set in stone the minute the agreement is signed. Except under exceedingly rare circumstances, no changes may be made to an irrevocable trust.
The benefactor, having transferred assets into the trust, effectively removes all rights of ownership to the assets and, for the most part, all control.
The main reason to select an irrevocable trust structure is taxes. Irrevocable trusts remove the assets from the benefactor's taxable estate, meaning they are not subject to estate tax upon death, and they also relieve the benefactor of tax responsibility for any income generated by the assets. Irrevocable trusts can be difficult to set up and require the help of a qualified attorney.
- Revocable, or living, trusts can be modified after they are created.
- Irrevocable trusts cannot be modified after they are created, or at least they are very difficult to modify.
- Irrevocable trusts offer tax-shelter benefits that revocable trusts to do not.