Revocable vs. Irrevocable Trusts
Trusts are created to give legal protection for a person’s assets, to make sure those assets are distributed according to that person’s wishes and to save time, and in some cases avoid or reduce inheritance or estate taxes.
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 make sure 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 trustee manages them. The trustee determines how the assets are invested and to whom they are distributed when the owner of the trust dies. A trustee must manage the trust according to the guidelines laid out when the trust was formed.
A revocable trust is also known as a living trust. These trusts can be modified after they are created. Beneficiaries can be changed, assets can be added or removed, etc. Sounds like a great option for a trust, but revocable trusts come with a few key disadvantages:
- The assets in the trust are not shielded from creditors. If they are sued, the trust assets can be ordered liquidated to satisfy a judgment.
- When the owner of a revocable trust dies, the assets held in trust are taxed: both state and federal estate taxes.
However, there are some advantages:
- A revocable trust avoids probate.
- A revocable trust safeguards a grantor’s wishes should he become incapacitated.
- Revocable trusts can include assets that would not be suitable for an irrevocable trust, such as qualified accounts like IRAs and 401(k)s.
The main reason to select an irrevocable trust structure is taxes.
The benefactor's assets in the trust are actually removed from his taxable estate, so they are not taxed upon death. The assets are not taxed if they generate income either. The owner no longer owns the assets when they are put in an irrevocable trust and has no control over them.
More details and considerations for a revocable or irrevocable trust can be found in this article.