To understand the key differences between an irrevocable trust and a revocable trust, we must first understand what a living trust is in the first place. In its simplest terms, a trust is a fiduciary relationship between three parties: the trustor (also known as the grantor), the trustee, and the beneficiary. The process is facilitated by a trustor. This agreement takes place when one party (the trustor) appoints another party (the trustee) to hold property for a third party (the beneficiary) in the event they die or are no longer mentally sound. It is quite common, however, for a person to be both a trustee and a beneficiary. For example, a wife may wish to create a trust and appoint her husband as both the trustee and beneficiary.
The primary reason people set up revocable trusts and irrevocable trusts is to avoid probate when they die. This prevents assets from being frozen—and surviving family members from having to spend lots of money—throughout the probate process. When a person passes away with a living trust, they have already designated one or more successor trustee(s) who have the ability to immediately disperse assets to the beneficiaries of the trust.
Comparing Revocable Trusts and Irrevocable Trusts
• Allows the trustor to retain power over trust assets and does not restrict them in any way during their lifetime
• Retains ownership and rights of assets
• Property is subject to estate taxes
• Assets are a countable resource for Medicaid purposes if you were to enter a nursing home
• Offers no lawsuit protection
• Avoids probate
• Keeps estate out of public records
• The trustor cannot reverse this trust or change its terms
• Removes all rights of ownership from the trustor and transfers ownership to the trust
• Property avoids the 40% federal estate tax and 16-20% state level estate tax (Oregon & Washington)
• Assets are NOT a countable resource for Medicaid purposes if you were to enter a nursing home
• Protection of trust assets during a lawsuit
• Avoids probate
• Keeps estate out of public records
Revocable living trusts can be revoked, changed, or amended at any time during the grantor’s trustor’s life. A revocable living trust accounts for three stages of the trustor’s life. First, it establishes that while the trustor is of sound mind, they will act as the trustee and manage their trust assets. Second, if the trustor becomes disabled to where they can no longer manage their finances, the trust will identify a new trustee. Third, the trust directs the trustee on the distribution of assets after the trustor dies. One of the pros about revocable trusts is that when a person places assets and property into one while they are alive, their assets remain under their ownership, and they can access them whenever they want to. Since people choose to create a trust to avoid probate, a revocable trust can be that good balance of control and protection that they’re looking for. A revocable living trust also protects people if they become disabled, because they have already appointed a trustee to make fiduciary decisions for them.
Irrevocable trusts, generally, cannot be revoked or amended. For example, if a person places property into an irrevocable trust, they no longer own that property: the trust owns it. Irrevocable trusts reduce federal and state estate tax and achieve some measure of asset protection for their family. Irrevocable trusts also protect your family if you become disabled and need nursing home care, since property in an irrevocable trust (and gifted in advance) is not countable by Medicaid. Therefore, this type of trust protects your family from losing their entire life savings in case long-term nursing care is needed.
Why choose a revocable trust over an irrevocable trust or vise versa?
For most people, creating a revocable trust might make the most sense because of the flexibility it allows. However, there are certain circumstances where a person would opt for an irrevocable trust. The powers that different people are granted in a trust dictate the protections that are in place. Unfortunately, because a revocable trust allows the grantortrustor to change or amend the trust at any time, it can lack the tax protection that some people may desire. If a person is looking to avoid estate tax, then an irrevocable trust is the right option, because property in that trust is no longer part of the person’s estate. Property that is placed in a revocable trust is still owned by the trustor, therefore estate tax applies. If this is not a concern—perhaps your estate is not worth close to the federal tax exemption—then a revocable trust may be a better option. Another reason that someone may opt for an irrevocable trust is due to Medicaid. Assets and property that are placed in the trust do not affect Medicaid qualification. Someone may set up an irrevocable trust is if they are likely to get sued i.e., they’re in law or medicine. If this is the case, setting up an irrevocable trust will keep their assets safe. Lastly, it is important to note that all revocable trusts become irrevocable after the person who sets up the trust passes away.
Living trusts are not so straightforward—there are many factors to consider when deciding how to structure your own trust. Choosing which type of trust is best depends on what you want to achieve with your estate plan. If you are considering either of these trusts, it is best to consult with an experienced estate planning attorney who will take time to understand your situation and identify which is the better route to take. If you are considering creating a trust, contact our office today.