When it comes to planning your estate, you have access to many tools that can help you cobble together a plan that achieves your objectives. Because your objectives may be different than the next person’s, the tools you use may be different as well. That takes us to the discussion of which is the right trust for you—a revocable trust or an irrevocable trust. They are similar to an extent, but they can play very different roles in your estate plan. So, it’s essential to know the difference between a revocable and irrevocable trust.
Both trusts are separate legal entities set up during your lifetime to manage your assets to ensure they are used in a way you deem appropriate. After your assets are transferred to the trust, they are managed by a third party (trustee). The trustee can determine how the assets are invested and how they are to be distributed when the grantor (you) dies. In both cases, the trustee must manage the trust according to the guidelines specified in the trust. For the most part, that’s where the similarities between a revocable and irrevocable trust end.
The fundamental difference between the two trusts is implicit in their names:
Revocable trust—a trust that can be revoked
Irrevocable trust—a trust that cannot be revoked
As their names imply, you can revoke, invalidate, or change a revocable trust at any time. However, you cannot revoke or change an irrevocable trust. Once you place assets inside a revocable, you can change your mind and remove them while living. However, at your death, the trust becomes irrevocable. If you place your assets inside an irrevocable trust, you are, in essence, gifting them to another entity, which means it can’t be revoked.
Once you understand that distinction, it’s useful to know how to work inside an estate plan. At the most basic level, the purpose of a revocable trust is to keep assets out of probate. In contrast, an irrevocable trust is used to keep assets out of an estate—two entirely different objectives. So, in determining which type of trust you should use, you need to be clear about your intentions and objectives for your estate.
As an example, if your estate is valued at less than $11.7 million (estate tax exemption for 2021), and your main goal is to help your family avoid the cost, delays, and publicity of settling your estate in probate court, a revocable trust is the best solution. Other reasons for establishing a revocable trust include:
In many cases, a standard will can lead to family disputes and challenges to alter it by a family member. With a trust, you instruct that any family member who posts a challenge to the trust be disinherited.
For a married couple with significant separate assets acquired before the marriage, a trust can help segregate assets from their community property assets.
A revocable trust can name a guardian for your children and dictate how much can be spent for the benefit of your children. It can also empower another person to act on your behalf if you should become incapacitated.
You can assign a professional trustee to manage your assets for the benefit of future generations, placing limits on withdrawals for family members.
Through the trust, you can create a credit shelter trust that can reduce estate taxes if your estate exceeds the combined estate tax exclusion amounts.
If your estate is valued at more than $11.7 million (the estate tax exemption amount in 2021), it could be liable for estate taxes. Currently, the top tax rate for estates is 40%. Since taxes are paid from the estate, they reduce the amount that passes to your family. The best way to maximize your estate for your family is to reduce its tax liability, and the only way to accomplish that is to remove taxable assets from your estate. One option is to establish an irrevocable trust. Any assets held in an irrevocable trust are assumed to be owned and controlled by the trust for the benefit of named beneficiaries, not you. As such, they are not includable in your estate for tax purposes. Specific reasons for using an irrevocable trust include:
Also known as a “living trust” or an “inter vivos” trust, a revocable trust is a legal arrangement in which the grantor grants property to the trust, which then owns the property. The trust is typically overseen and controlled by the grantor acting as trustee while living. The grantor can name a successor trustee who steps in when the grantor dies. When the grantor dies, the trustee has a fiduciary obligation to ensure the trust provisions are executed as directed. When the estate is settled, the trustee distributes the assets directly to named beneficiaries as instructed without the need to go through a probate proceeding. The trustee manages any assets remaining in the trust for future distribution.
An irrevocable trust is not so straightforward and, because there are tax implications, it should be drafted with the guidance of an estate attorney.
The basic arrangement of an irrevocable trust is similar to that of a revocable trust. Except, rather than transferring assets that the grantor can still control, the assets are gifted irrevocably to the trust with total control handed over to a trustee named by the grantor. The grantor can designate beneficiaries and include specific instructions for distribution. If the grantor wants to change any of the terms of the trust, it must be done with the permission of the trustee and the beneficiaries.
There are several types of irrevocable trusts that can be used to achieve different objectives.
Irrevocable life insurance trust: When an irrevocable trust houses a life insurance policy, the death proceeds are not included in the estate for tax purposes.
A grantor-retained trust (GRAT) allows for large financial gifts to family members with minimal taxes. A spousal lifetime access trust (SLAT) allows a grantor to take advantage of the estate tax exemption to provide a spouse with lifetime income. A qualified personal residence trust (QPRT) allows the owner of a residence to remove it from the estate while continuing to live in it.
A CRT is a split-interest gifting instrument that allows a grantor to receive a current tax deduction for contributions and donate the remaining assets.
These different types of irrevocable trusts are designed for people with wealth to achieve their wealth transfer objectives while minimizing current or future taxes. But you don’t necessarily have to be wealthy to take advantage of an irrevocable trust. While they may not have as much value if you have less than $11.7 million in assets, they could when the estate tax laws change, as they typically do from time to time. In fact, the current estate tax structure is expected to expire at the end of 2025, when the estate tax exemption is scheduled to revert to $5 million, which will affect many more people.
Just about anyone with any amount of assets can benefit from a revocable trust. They’re relatively inexpensive and straightforward to administer. Families with assets approaching $10 million should consider, along with the guidance of an advisor, the benefits of an irrevocable trust if their objective is to maximize their estate for the benefit of their children. Your financial advisor is in the best position to advise you on the suitability of either.
Estate planning is never a set-it-and-forget-it proposition. Not only are the federal and state estate tax laws constantly changing but so are your personal circumstances. It’s highly advisable to review your estate planning needs periodically to ensure you achieve your family’s objectives. You certainly don’t want your children to have to pick up the pieces if your plan is not current. We invite you to schedule a complimentary consultation with a Dechtman Wealth Management advisor to discuss your estate planning needs.