Irrevocable trusts and revocable trusts differences are critical and key to making an informed decision about the best device available for a family’s situation in estate planning. These two devices are very different in effect and each serves very different purposes. Here are some of the major differences between the two devices which can help in determining which type of trust is more suitable to an individual’s needs.
1. Ownership of the Property
Once assets are placed in an irrevocable trust, the property no longer belongs to the Grantor; it now belongs to the trust. That does not mean that one can no longer live in the house that they have lived for 30 years or that one can no longer drive the car owned by the trust, it just means that you don’t own it. Just like renting a house or leasing a car, the assets are still there for your benefit and a trust can sell the house and buy another that can be lived in. A properly set-up, implemented, and funded irrevocable trust can provide the best possible protection of assets from claims by creditors, as the assets have literally changed ownership. This is very different from a revocable trust situation where the Grantor retains completed ownership of the property.
An irrevocable trust agreement generally cannot be changed, amended, modified or revoked even with a court order, thus offering the coveted asset protection, whereas a revocable trust allows the instrument to be modified or revoked at the Grantor’s discretion; this means that the assets in a revocable trust are still available for anyone to take. The term ‘irrevocable’ generally implies that the trust cannot be changed under any circumstances, but this may not be the case: A special power of appointment in the trust document may allow the Grantor the freedom to modify the named beneficiaries at his discretion without affecting the benefits of the irrevocable trust.
3. Estate Taxes
With an irrevocable trust, since the Grantor no longer owns the property, it is not included in calculations of the total value of property at the time of death. With a revocable trust, since the Grantor still owns the property, the value of the property in the trust will be included in the calculation of the total value of property at the time of death.
4. Protection of Assets
With an irrevocable trust, since the assets in the trust no longer belong to the Grantor, they are generally protected from creditors or from other claimants. This serves to protect assets from the claims of creditors, Medicaid, and even divorcing spouses. This device has been used to avoid Medicaid restrictions which require an elderly person who is going into a nursing home to spend a majority of his own money before Medicaid provisions kick in (referred to as spend-down provisions). This advantage also comes into play for individuals seeking to shield assets from legal claims. In opposition, with a revocable trust, the assets are not protected: since the Grantor retains full control and power over the assets, he is still liable for legal claims against the assets.
5. Medicaid Planning Purposes
With an irrevocable trust, one of the prime benefits sought during elder planning is to enable the elderly Grantor to obtain Medicaid benefits if he moves into a nursing home: By placing assets into an irrevocable trust five years ahead of the actual need, the Grantor has secured his assets for the benefit of named beneficiaries. This does not work in the case of revocable trusts, where the Grantor remains ownership of the assets.
6. Appointment of Trustee
With an irrevocable trust, the Trustee generally is, and should be, an independent person chosen by the Grantor in order to create a fiduciary duty to protect the assets – family members as a Trustee does not offer this same benefit. The Trustee will manage the assets in the trust and is bound by its provisions. By having a Trustee who is a separate entity from the Grantor, it is apparent that the Trustee is exercising independent control over the trust assets. With a revocable trust, the Grantor often also serves as the Trustee, maintaining control over the assets in the trust.
7. Income Tax Return
With an irrevocable trust, generally, the trust has its own tax identification number (EIN), files a 1041, and then either pays the tax itself (not typical) or issues a K-1 to the Grantor (or the Beneficiaries if Grantor is deceased) for income which flows through to the recipient’s 1040 return through Schedule E. With a revocable trust, there is no such discrepancy, the taxpayer files everything on their 1040 as if they personally owned the assets that generated income – because they do own the assets if they are within a revocable trust!
After reviewing the major differences between irrevocable and revocable trusts, it is clear that the main purpose of an irrevocable trust is to protect assets: It prevents the property from being included in the valuation of total assets of the decedent at the time of death, thereby protecting the assets within the trust from estate taxes as well as the probate process, and it protects the assets from creditors because they no longer own the asset. In contrast, the main purpose of a revocable trust is to avoid the process of probate, thus simplifying the transfer of assets to named beneficiaries and removing the probate court from the process. Deciding whether one of these two devices will meet the needs of the Grantor depends upon the ultimate goals for the trust.
As with all estate planning, the laws can change, so a consultation with an expert is advised before determining which device is more appropriate for the individual situation.