Revocable trust or irrevocable trust: How do you decide?

A trust is a legal arrangement in which you (the grantor) transfer ownership of your assets to a trustee, who manages and distributes those assets according to your wishes for the benefit of your chosen beneficiaries.

Trusts offer several advantages over simple wills, including avoiding probate, maintaining privacy, providing control over asset distribution, potential tax benefits and protection from creditors.

The primary purpose of a revocable trust, also known as a revocable living trust, is to enable the transfer of assets to beneficiaries outside of the probate process and provide for the continuity of asset management during your lifetime if necessary due to your incapacity or other specified reasons. As the name suggests, you can modify, amend or even revoke this type of trust at any time while you're alive and mentally competent.

Revocable trusts offer flexibility, allowing you to change beneficiaries, add or remove assets or terminate the trust entirely. As creator, or grantor, of the trust, you serve as the trustee, managing the assets as you see fit. Assets funded (or titled) into the trust bypass probate, simplifying the transfer process for your heirs and beneficiaries. The terms of the trust remain private, unlike a will that becomes part of the public record. Additionally, a successor trustee can manage your trust’s assets and related affairs if you become incapacitated and take over trust management after your passing.

Revocable trusts allow you to maintain control over assets, are easy to modify, avoid probate, protect privacy and provide a smooth transition of asset management if you become incapacitated. Some drawbacks are that they offer limited asset protection, no tax benefits, require ongoing management and may have higher initial setup costs compared to a simple will.

An irrevocable trust is a more permanent estate planning tool than a revocable trust, and once established, it generally cannot be changed, modified or revoked without the consent of the beneficiaries. When you create an irrevocable trust, you effectively transfer control of the assets to the trust. Irrevocable trusts offer strong asset protection, with trust assets generally shielded from creditors and lawsuits. Properly structured irrevocable trusts can provide estate tax benefits by reducing the taxable estate. Some irrevocable trusts can be used for Medicaid planning, helping to protect assets while qualifying for benefits. Certain types of irrevocable trusts also facilitate charitable giving while providing tax advantages.

Irrevocable trusts offer significant benefits, including asset protection, estate tax reduction, Medicaid planning opportunities, charitable giving benefits and certainty for beneficiaries. However, they also come with drawbacks, such as loss of control over trust assets, inflexibility in modifying trust terms, complexity in setup and management and potential tax implications when transferring assets to the trust.

Choosing between a revocable and irrevocable trust depends on your specific financial situation, estate planning goals and personal preferences. Due to the complexities of estate planning, the advice of an experienced estate planning attorney who can provide personalized guidance based on your specific situation is often recommended.

Deciding between a revocable and irrevocable trust is a significant decision that can have long-lasting implications for your estate plan. Here are some steps and key factors to help you make an informed choice:

• Assess your estate planning goals. Clearly define what you want to achieve with your estate plan, such as avoiding probate, reducing taxes, protecting assets or providing for loved ones.
• Evaluate your financial situation. Consider the size of your estate, types of assets, potential tax liabilities and any special circumstances (e.g., business ownership, blended families). If your estate is likely to be subject to estate taxes, an irrevocable trust may be more beneficial. As of 2024, the federal estate tax exemption is $13.61 million per individual ($27.22 million for married couples). If your estate exceeds these thresholds, an irrevocable trust could help reduce your taxable estate.
• Consider your comfort level with control. Determine how important it is for you to maintain control over your assets during your lifetime.
• Review and update regularly. Whichever type of trust you choose, remember that estate planning is an ongoing process. Review your plan periodically and make updates as needed to reflect changes in your life, finances or goals.
• Assess asset protection needs. If protecting your assets from potential creditors or lawsuits is a primary concern, an irrevocable trust offers stronger protection. Assets in a revocable trust are still considered part of your estate and can be reached by creditors.
• Consider Medicaid planning. For those concerned about potentially needing long-term care and qualifying for Medicaid, certain types of irrevocable trusts can be used as part of a Medicaid planning strategy. These trusts can help protect assets while still allowing you to qualify for Medicaid benefits after the five-year look-back period.
• Determine need for flexibility vs. certainty. If you value the ability to make changes to your estate plan as circumstances change, a revocable trust offers the most flexibility. On the other hand, if you want to ensure that your wishes are carried out exactly as specified and provide certainty for your beneficiaries, an irrevocable trust may be more suitable.
• Consider charitable giving. If charitable giving is an important part of your estate plan, certain types of irrevocable trusts, such as charitable remainder trusts or charitable lead trusts, can offer tax advantages while supporting your philanthropic goals.
• Be aware of complexity and cost. Generally, irrevocable trusts are more complex to set up and manage than revocable trusts. They often require ongoing professional assistance to ensure compliance with tax laws and trust regulations. This complexity can result in higher setup and management costs.

Yes, it's possible and sometimes beneficial to have both types of trusts as part of your comprehensive estate plan. For example, you might use a revocable trust for the majority of your assets to avoid probate and maintain control, while also establishing an irrevocable trust to preserve ownership of a family vacation home for subsequent generations or an irrevocable life insurance trust (ILIT) to remove your life insurance policy from your taxable estate.

When the grantor of a revocable trust dies, the trust typically becomes irrevocable. The successor trustee named in the trust document takes over management of the trust assets and begins the process of distributing them according to the trust's terms.

While it's generally difficult to change or terminate an irrevocable trust, there are some circumstances under which it may be possible. These include obtaining consent from all beneficiaries, seeking court approval if circumstances have changed significantly or using the process of "decanting" in states that allow it.

For income tax purposes, a revocable trust is considered a "grantor trust," meaning that all income generated by the trust is reported on your personal income tax return. There are no special income tax benefits or consequences associated with a revocable trust during your lifetime.

Generally, assets properly transferred to an irrevocable trust are protected from the grantor's creditors. However, there are exceptions, such as fraudulent transfers or certain claims by the government. Additionally, the level of protection may vary depending on state law and the specific terms of the trust.

Choosing between a revocable and irrevocable trust is a significant decision that can profoundly impact your estate planning strategy. Both types of trusts offer unique advantages and serve different purposes in protecting your assets and providing for your beneficiaries. Revocable trusts offer flexibility and control, making them ideal for those who want to maintain authority over their assets while still avoiding probate. On the other hand, irrevocable trusts provide stronger asset protection, potential tax benefits and can be valuable tools for Medicaid planning and charitable giving.

The decision between these two types of trusts – or whether to utilize both – depends on your specific financial situation, estate planning goals and personal preferences. Factors such as the size of your estate, your comfort level with relinquishing control, asset protection needs and long-term care considerations all play crucial roles in this decision-making process.

Given the complexities of trust law and the significant implications of these decisions, it's highly recommended to consult with an experienced estate planning attorney. A qualified professional can provide personalized guidance, help you navigate the intricacies of different trust options and ensure that your estate plan is tailored to your specific situation. By taking the time to understand your options and make informed decisions, you can create a robust estate plan that provides peace of mind and secures your legacy for generations to come.