Revocable Trust vs. Irrevocable Trust: What’s the Difference

Revocable Trust vs. Irrevocable Trust: What’s the Difference?

A trust is a separate entity in charge of the assets you transfer to it. You can set up a trust at any time, and dictate how the funds are used while you’re alive, and leave instructions for when you’re gone.

Once the assets are in the trust, the trustee manages them. Trusts are a great way to protect your assets and even avoid capital gains, estate taxes, and probate. Sometimes you are the trustee and other times, a third-party is the trustee.

It all comes down to one important decision – revocable or irrevocable trust. Which one is right for you?

What is a Revocable Trust?

A revocable trust is also known as a living trust. In a revocable trust, you can change it. This includes changing beneficiaries, and the instructions on how to manage the assets.

The downside of a revocable trust is the assets aren’t as protected as they are in a revocable trust. In other words, if someone sues you, the court can order you to liquidate your revocable trust to pay the other party.

A revocable trust remains in your name (you are the trust). This allows you to transfer assets in and out of the trust and even refinance your home, taking it out of trust and putting it right back in after the closing.

How Does it Work?

Since you’ll be alive when you have a revocable trust, you are usually the trustee or person managing the estate. You’ll also name a successor trustee who will take over when you can no longer manage the trust. You can set the parameters for when that would happen and then rest assured that your estate will be in good hands.

You determine which assets you want to transfer to the trust and who you will name as beneficiaries for the assets. You may need to contact the appropriate entities holding the assets to make sure the accounts are held in the trust’s name.

All assets in your revocable trust are your responsibility at tax time. Your trust has your Social Security number, and any earned income will increase your tax liability.

What is an Irrevocable Trust?

An irrevocable trust is a trust you cannot change. Once you set up the trust and sign the agreement, nothing can change.

An irrevocable trust has a trustee and beneficiaries like a revocable trust, but you cannot be the grantor. When you put assets in an irrevocable trust, you cannot touch them, and this includes selling them. For example, if you put your property in an irrevocable trust, you can’t sell it (in most cases).

How Does it Work?

Once you set up an irrevocable trust, the assets sit there until you pass away and the trustee disburses the assets.

The nice thing about an irrevocable trust is creditors and any suing you cannot touch the assets because they don’t belong to you. The same is true of your tax filing, you don’t claim the income on your tax return as your Social Security number isn’t tied to the trust.

What are the Main Differences?

We’ve named some obvious differences between a revocable and irrevocable trust, but they are worth repeating.

• The name tells it all for each trust – one you can change (revocable) and one you cannot (irrevocable).

• If you need to change an irrevocable trust, you can only do so with beneficiary approval.

• Revocable living trusts have no tax benefits or protection from creditors, but irrevocable trusts don’t increase your taxes and they provide asset protection.

• Assets in an irrevocable trust don’t create a tax liability.

The Benefits of an Irrevocable Trust

The irrevocable trust doesn’t sound like a favorable option for most people since you can’t make changes, but there are some benefits you may want to consider:

• Asset protection – Since the assets no longer belong to you when you place them in an irrevocable trust, creditors and lawsuits can’t come after the money. The money is now under the control of an independent trustee, who makes all the decisions and disburses the funds according to the directions.

• Tax protection – Since the assets in an irrevocable trust aren’t in your name, you also don’t pay taxes on them.

• Estate protection – If your estate is near the limit of tax protection on estates, an irrevocable trust can keep the estate value down, decreasing the risk of triggering estate taxes.

• Charity deductions – If you put the money in a charitable trust, you get the tax deduction for the year you contribute, much like you would if you contributed cash to a charity. If you instruct the trustee to donate the assets to charity upon your passing, the deduction goes to your estate.

Bottom Line

Both a revocable and irrevocable trust has benefits. It comes down to what you want out of your trust. If you’re trying to protect your assets and preserve them for your beneficiaries, an irrevocable trust may be the right option, just make sure you don’t transfer anything you want access to while you’re alive.

If you want a trust overseeing your assets so you know your beneficiaries are cared for, but you want some flexibility, the revocable trust is a better choice. Irrevocable trusts are usually reserved for the very wealthy who need the trust to take assets to lower the chance of triggering estate taxes.