There are two main types of living trusts – revocable and irrevocable trusts. Each has their own benefits and caveats, and choosing which one is right for your individual situation can seem complex. Understanding the differences between these two types of trusts is key to selecting a trust that properly protects your assets and accomplishes the financial goals you have for yourself and your family.
What Is a Revocable Living Trust?
A revocable living trust is just that – revocable. This means that it can be changed, altered, or even eliminated during the lifetime of the grantor, or the trustmaker. A revocable living trust can be self-settled, meaning that the grantor of the trust is also the beneficiary, or it can be a third party trust in which the beneficiary is another person. The primary benefit of this type of trust is to avoid probate at the time of death while simultaneously maintaining complete control over the trust while the grantor lives.
What Can a Revocable Living Trust Be Used For?
A revocable living trust is primarily used to avoid probate at the time of the grantor’s death. When the assets are owned by the trust, they are not subject to the probate process and are instead distributed directly to the beneficiary of the trust.
Additionally, a revocable living trust can provide the grantor with protection against a conservatorship in the event that he or she becomes incapacitated. Instead of the incapacitated individual’s family having to go to court to obtain a conservatorship to manage their assets for them, the individual’s trustee successor is immediately replaces the role of the grantor and assumes control over the trust.
What Can’t a Revocable Living Trust Do?
Unfortunately, a revocable living trust cannot be used to protect your assets from creditors or to allow you to remain eligible for government benefits that have an asset limit, like Medicaid and Social Security Disability. They also cannot be used to protect your assets from federal estate taxes and state inheritance taxes. Because the grantor still has control over the trust during his or her lifetime, the assets contained within the trust are still considered to belong to the grantor for the purposes of Medicaid planning and debt settlement.
What Is an Irrevocable Living Trust?
An irrevocable living trust cannot be changed, altered, or canceled after the trust has been established. A revocable living trust becomes irrevocable at the time of the grantor’s death, however, when an irrevocable living trust is created as such at the time the trust is established, it remains so throughout the life of the grantor. In some very specific cases, you may be able to have an irrevocable trust modified. For example, if you have a charitable trust, you may be able to modify the terms of the trust to comply with newly passed federal or tax laws.
What Can an Irrevocable Living Trust Be Used For?
One of the primary reasons an irrevocable living trust is created is to protect the grantor’s assets from estate taxes. Because the ownership of the assets is transferred from the grantor to the trust itself, and the grantor has no control over the trust, these assets do not have to be counted when valuing the grantor’s estate. When the grantor passes away and the estate is taxed, assets and property held in the irrevocable trust will not be taxed.
An irrevocable living trust can also be utilized to protect a grantor’s assets against debt settlement judgments or when adding up assets to determine eligibility for government programs like Medicaid or Social Security Disability. Since the grantor has transferred ownership of the assets to the trust, they can no longer be counted as the grantor’s assets. A creditor cannot successfully obtain a judgment against an irrevocable trust, nor will the assets held in an irrevocable trust cause a disabled person to become ineligible for government benefits.
What Are the Caveats of an Irrevocable Living Trust Do?
As with any type of trust, there are some caveats to establishing an irrevocable living trust. While the assets held in this type of living trust are protected from taxation, any income that the trust earns must be reported separately. This means that a separate tax return must be filled out for each irrevocable trust, and a Schedule K-1 must be completed for each beneficiary that received payments from the trust during the tax year. Additionally, the taxes that must be paid trusts are typically higher than income taxes. However, by distributing assets among beneficiaries in certain amounts, it may be possible to put the trust in a lower tax bracket.
How to Choose Between a Revocable and an Irrevocable Living Trust
Choosing which type of trust to establish can seem overwhelming. Each has their own benefits and drawbacks, and each can help you accomplish different goals. Discussing your individual estate planning needs in detail with an experienced attorney is key to determining which type of trust you should form and how the terms of your trust need to be structured.