When it comes to estate planning, understanding the differences between a living (revocable) trust, an irrevocable trust, and a will is crucial. Each option serves a unique purpose and comes with its own set of advantages and disadvantages. Let’s dive into the specifics to help you decide which one might be the best fit for your needs.
What is a Trust?
A trust is a separate legal entity a person sets up to manage their assets. Trusts are set up during a person’s lifetime to assure that certain assets are used in a way that the person setting up the trust deems appropriate. Once assets are inside a trust, a third party, known as a trustee, manages them. The trustee determines how to invest the assets and to whom to distribute the assets to when the trust owner dies. However, a trustee must manage the trust following the guidelines that were laid out when the trust was formed.
At this point, it’s very important to emphasize that once you set up a trust you are not done with your estate planning. You must retitle your assets into the trust! Too many people create trusts with an attorney, but never retitle assets into the name of the trust.
There are two basic types of trusts. We will define and discuss revocable vs irrevocable trust. See below for information about each and how to choose the right one for you.
Living (Revocable) Trust
A living trust, also known as a revocable trust, is a flexible estate planning tool that you can modify or revoke at any time during your lifetime. That means the owner of a revocable trust may change its terms at any time. Therefore, the assets in a revocable trust technically still belong to you. This means you are able to change the terms of the trust while you are alive.
There are several benefits of creating a living trust:
- Assets in a living trust bypass the probate process, which can save time and money. So, it bypasses the one-year waiting period that’s needed for probate, and the assets can go directly to your beneficiaries.
- You retain control over the assets in the trust and can make changes as needed.
- Unlike a will, a living trust is not a public document, so the details of your estate remain private.
- In the event you become incapacitated, the successor trustee can manage the trust assets without court intervention.
- A revocable trust becomes effective as soon as you sign the legal document and assets are titled in the name of the trust.
The downside of a revocable trust is that:
- Setting it up can be more complex and expensive than creating a will.
- It won’t protect your assets from creditors in the event the owner is sued.
- It doesn’t shield the assets from a nursing home the way the irrevocable trust can.
- The assets held in trust are subject to state and federal estate taxes when applicable.
- You need to actively manage the trust and ensure that assets are properly titled into the name of the trust.
Irrevocable Trust
Like revocable trusts, irrevocable trusts also avoid probate and preserve privacy. However, once established, generally cannot be modified or revoked without the consent of the trustees and perhaps beneficiaries and, in some cases, court approval. In fact, you can think of the irrevocable trust as a different entity than you. The assets in the irrevocable trust are no longer yours, as you’ve gifted them to the trust and cannot take them back.
The benefits of an irrevocable trust include:
- Assets in an irrevocable trust are protected from creditors and legal judgments. Just be aware that there’s a five-year look-back period in Massachusetts as it relates to protection from nursing home costs. So, if you’re elderly and need to go into a nursing home tomorrow, you can’t create an irrevocable trust today and protect those assets. You need to plan ahead and create that trust in advance.
- Irrevocable trusts can offer significant tax advantages, in particular estate tax reduction.
- Assets in an irrevocable trust are not considered when determining eligibility for Medicaid.
One of the limitations with an irrevocable trust is that many things can change. And because you gave up control and ownership of your assets, you are not able to make the needed changes.
Another limitation is what if your financial situation changes? When setting up the irrevocable trust, you need to balance the amount of assets you remove from your estate with the potential that you might need those assets in the future. Therefore, creating and managing an irrevocable trust is complex and requires legal assistance.
Will
A will is your intention of where your assists will go after you pass. In the will, you will name your beneficiaries. Once you pass, the will is filed at a local courthouse.
At this point, a specified period of time has to pass before the assets can be distributed. If the deceased party owes money, during this time period known as the probate process, parties have the right to obtain the money they are owed.
A benefit of having a will is you know exactly where your assets will go after you pass. Wills are generally easier and less expensive to create than trusts. You can change or revoke your will at any time during your lifetime. Plus, a will allows you to name guardians for minor children.
But the downside of having only a will includes:
- Assets distributed through a will must go through the probate process, which can take up to one year for your assets to be distributed and can be costly.
- Once submitted for probate, a will becomes a public document.
- Wills do not provide the same level of control over how assets are managed after your death compared to trusts.
- Wills are more easily contested.
Which is best for you?
Choosing between a living trust, an irrevocable trust, and a will depends on your specific needs and goals.
- The revocable trust gives you flexibility and control over your assets during your lifetime. It is a way to pass along assets to your beneficiaries in a low-cost, simple way without having to wait for probate.
- The irrevocable trust protects your assets while you’re living so your beneficiaries get exactly what you want them to have when you die. It also minimizes the effects of estate taxes that we have here in Massachusetts and at the Federal level.
- A will could be the right choice if you prefer a simpler and less expensive option for distributing your assets.
It’s essential to consult with an estate planning professional to determine the best approach for your unique situation. They can help you navigate the complexities of each option and ensure your estate plan meets your goals and protects your legacy. The expert will help you consider the best estate planning tool for your personal situation.
We consider estate planning to be part of your overall comprehensive financial plan. If you want a referral to a quality estate planning attorney, feel free to contact us. We’re here to help you make the best decisions for your future and your family’s security.
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