Understanding the similarities and differences of revocable and irrevocable trusts

A trust is a legal entity created to hold assets intended to be distributed to beneficiaries, which can be people or entities, with a trustee managing trust assets according to the provisions of the trust. Trusts are multifaceted and used for various purposes, but their primary function is to hold and manage assets for the benefit of specific people or entities, separating the legal ownership of those assets from the individuals or entities who benefit from them.

The person who creates the trust is known as the grantor or settler. The grantor determines its purpose, its rules and transfers ownership of assets into the name of the trust, which is a process known as “funding” a trust. Assets are essentially titled in the name of the trust and not the grantor.

Trusts can be broadly categorized into two categories: revocable and irrevocable. A revocable trust can be changed or terminated by the grantor during their lifetime. In contrast, an irrevocable trust typically cannot be altered after its creation. Each type serves different purposes and has distinct tax and asset protection implications.

Creating a trust is a methodical process that provides a structured way to manage and distribute assets. While the process is detailed, the peace of mind and potential benefits such as asset protection, tax savings and probate avoidance can make it a worthwhile endeavor. Consulting with an estate planning attorney can ensure the trust aligns with your goals and legal requirements.

Creating a trust involves a series of legal and strategic steps, each crucial to ensure that the trust operates as intended and serves the purposes for which it was established.

The first step is to determine the primary purpose of the trust. Common reasons include avoiding probate and serving as a substitute for a last will and testament; reducing estate taxes; protecting assets from creditors; managing assets for beneficiaries who might not be financially savvy or too young; and for special needs planning for beneficiaries with disabilities. For many people, a trust is their central estate planning document.

The grantor then must identify the assets they intend to fund, or title, into the trust. These assets could include real estate; bank accounts; stocks and bonds; personal property like jewelry, art and vehicles; and even business interests and intellectual property.

The grantor must decide on who or what will benefit from the trust’s assets. Beneficiaries can be individuals, charities or other entities. Beneficiaries can have a fixed interest (a set amount/percentage) or a discretionary interest (where the trustee decides distributions).

The trustee is responsible for managing the trust and ensuring the terms are followed. The trustee can be an individual, a professional (like an attorney) or a financial institution. The grantor of a revocable trust typically serves as trustee during their lifetime and names a successor trustee to take over trust management upon the grantor’s incapacity or death. However, a trustee for an irrevocable trust should not be the grantor in order to preserve key benefits of creating an irrevocable trust, like removing assets from the grantor's estate for tax purposes and providing asset protection.

The trustee is responsible for managing the trust, whether it is revocable or irrevocable. This involves handling investments, making decisions about asset distribution and ensuring the trust's terms are upheld. There can be more than one trustee.

Trusts are complex legal documents, and they are typically created with the assistance of an experienced estate planning attorney. The trust document will detail the trust's terms and conditions, the responsibilities and powers of the trustee, directions for distributing the trust’s assets and provisions for various scenarios, such as the death or incapacity of the trustee.

While there are DIY trust templates available, due to the legal intricacies and implications of creating a trust, experts highly recommended working with an experienced estate planning attorney to prevent unintended consequences and negative outcomes.

One formality in forming a trust is the creation and signing of the trust agreement, which is the legal document that establishes the trust, outlining its terms and purposes. It also names the trustee and beneficiaries.

The signing of the trust agreement also much be accomplished in accordance with state laws that may require notarization and independent witnesses. Working with an attorney to establish a trust can ensure that all formalities are followed to make the trust legally valid.

For the trust to be operational, you must transfer the chosen assets into it. This process, known as funding the trust, varies based on the type of asset.

If the asset is real estate, it requires a new deed that transfers ownership from the individual to the trust.

Funding a bank account into a trust requires opening new accounts in the trust's name or changing ownership of existing accounts. When it comes to personal property, assets typically can be transferred via an assignment of ownership document.

The trustee manages the assets within the trust. Their role and powers will be outlined in the trust agreement, which may include investment decisions, distribution to beneficiaries, payment of taxes, keeping records and accounting.

Based on the trust's terms, the trustee is responsible for distributions made to beneficiaries. For instance, a trust might stipulate that a beneficiary receives income from the trust assets when they reach a certain age or upon a specific event like graduating from college.

A trust will typically have terms that dictate when it should terminate. This might be a specific date, when an event occurs (e.g., when a beneficiary reaches a certain age), or when the trust's purpose is accomplished. Once the trust terminates, the assets are distributed to the residual beneficiaries, as specified in the trust document.

• Avoidance of probate: One of the main benefits of some trusts, especially revocable living trusts, is avoiding probate – the legal process of distributing a deceased person's assets.
• Tax planning: Irrevocable trusts are commonly used as part of an overall strategy to minimize estate and inheritance taxes or to preserve ownership of assets, such as a vacation home, for future generations.
• Control: Trusts allow the grantor to dictate terms and conditions for beneficiaries to receive assets, ensuring their wishes are followed.
• Asset protection: Some trusts, especially irrevocable trusts, can protect assets from creditors or legal judgments.
• Privacy: Trusts, unlike wills, are not public records, providing a level of confidentiality to the assets and their distribution.

The primary purpose of a revocable living trust, as the name suggests, is its flexibility. An individual can create this trust and retain the right to amend, modify, or terminate it during their lifetime. It primarily allows for the seamless transfer of assets upon death without the need for probate. It provides privacy, as the details of the trust remain private, unlike wills. It offers a mechanism to manage assets during incapacity.

Irrevocable trusts are established to provide a more fixed structure. Once assets are transferred to this trust, the trust terms cannot be easily modified, and assets cannot be readily withdrawn. One main purpose is to provide asset protection from creditor or legal claims made against the grantor of the trust. Other purposes are to minimize estate taxes upon the death of the grantor and to ensure specific conditions for beneficiaries, such as spendthrift provisions, are carried out.

Both types of trusts are important estate planning tools. Both revocable living trusts and irrevocable trusts are instruments used to manage and distribute assets upon the incapacity or death of the grantor. They also are used as a strategy to prevent court-appointed guardianships and conservatorships when a surrogate decision-maker is needed but not specified in planning documents.

Both types of trusts can appoint a trustee to manage the assets, ensuring that they're used according to the grantor's wishes. Both types of trusts also allow for beneficiaries to be named as recipients of trust assets.

Flexibility is the main difference between the two. Revocable living trusts can be altered during the grantor's lifetime, while irrevocable trusts cannot be easily changed once established.

Tax implications are another area. Assets in a revocable trust are considered part of the grantor's taxable estate, meaning they may be subject to estate taxes upon death. Conversely, assets in an irrevocable trust are not considered part of the taxable estate, which can lead to potential estate tax savings.

Protection from creditors is a key distinction. Revocable living trusts do not offer the same level of protection from creditors as irrevocable trusts. Assets within an irrevocable trust are generally protected from the grantor's creditors.

Also, with revocable trusts, grantors maintain control over their assets. With irrevocable trusts, the grantor relinquishes some degree of control.

With a revocable trust, the grantor can amend, modify or even dissolve the trust at any time during their lifetime, as long as they are mentally competent. This means the grantor retains significant control over the assets and the terms of the trust. Because of this control, assets within a revocable trust are typically considered part of the grantor's taxable estate for estate tax purposes.

In contrast, once an irrevocable trust is established and assets are transferred into it, the trust generally cannot be altered, amended or revoked by the grantor without the consent of the trust's beneficiaries or, in some cases, a court order. This means the grantor relinquishes a degree of control over the assets. Assets transferred into an irrevocable trust are typically removed from the grantor's taxable estate (assuming certain conditions are met), which can provide estate tax benefits.

Let’s consider a couple of brief scenarios of how each type of trust may be used. For example, Jane, a widow, owns several properties and wishes to ensure that they are passed to her children without the hassle of probate. She sets up a revocable living trust, transferring the titles of these properties to the trust. Upon her death, the properties funded into the trust are distributed to her children seamlessly.

John, however, has decided to create an irrevocable trust. John has a significant estate and is concerned about potential estate taxes upon his death. He establishes an irrevocable trust, transferring a portion of his assets to it, thus removing them from his taxable estate and minimizing future estate tax liability. In another example, Mary is concerned that her son, a spendthrift, will squander his inheritance. She sets up an irrevocable trust with terms that only allow him to receive a small, fixed amount every month, protecting the principal from his imprudent spending.

Trusts are a cornerstone of estate planning, offering diverse strategies for asset management and distribution. Revocable living trusts provide flexibility and control, making them suitable for those seeking to bypass probate and maintain privacy. On the other hand, irrevocable trusts are robust tools for asset protection, estate tax planning and setting concrete terms for beneficiaries.

Choosing between the two depends on individual needs, financial circumstances and long-term goals. It's always recommended to consult with an estate planning attorney when considering which trust structure is best suited for your situation.