Financial Planning

Revocable vs Irrevocable Trust

Published by Bob Gustafson

Revocable vs Irrevocable Trust

Before we dive into the differences between a revocable vs an irrevocable trust, let’s first discuss two items. One, if you’re seriously considering creating a trust, it’s important to contact an attorney. We’ll discuss these trusts in general, but attorneys are the experts in this area. Secondly, before jumping into types of trusts, let’s define 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.

What is a revocable trust?

Revocable trusts are living trusts. 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.

For example, you can remove beneficiaries, designate new ones, and modify stipulations on how assets within the trust are managed. Let’s take a look at the following example to see how the trust works and its benefits and disadvantages.

A person puts assets, let’s say a house, in the name of a trust while they’re alive. The benefit of doing that is that when that person dies, the house automatically becomes the property of the beneficiaries without going to probate. However, if that person left the house to their children in a will, they would have to go through probate, which is a public process, before they could become owners of the house. 

The advantage of using a living trust is that you can avoid probate and get access to assets immediately upon the death of the owner. Probate can be costly and time-consuming so using a revocable trust can reduce these burdens.

Another benefit is that a revocable trust becomes effective as soon as you sign the legal document and assets are titled in the name of the trust.

Some disadvantages of a revocable trust include:

  • Costs more up-front to create the revocable trust than a simple will. 
  • Doesn’t protect assets from creditors in the event the owner is sued.
  • The assets held in trust are subject to state and federal estate taxes when applicable.
  • Doesn’t shield the assets from a nursing home the way the irrevocable trust can.

What is an irrevocable trust?

Like revocable trusts, irrevocable trusts also avoid probate and preserve privacy. However, with the irrevocable trust, you aren’t able to make changes without the consent of the beneficiaries. If you’ve designated certain assets to certain people, then those assets are spoken for. In essence, you’ve given them away, and they are no longer yours.

One of the benefits of removing assets from your estate using the irrevocable trust is they can’t be reached by Medicaid if you need to enter a nursing home. Since the assets are no longer yours, the nursing home cannot tap into those assets while you’re still alive. 

One stipulation to note about asset protection. There’s a five-year look-back period when applying for Medicaid. So, if you create an irrevocable trust right before you go into a nursing home, the trust does not fully protect your assets until the irrevocable trust has been in place for five years.

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. For example, if one of your beneficiaries is a friend and you have a falling out, you may not be able to remove them as a beneficiary.

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.

Which trust is the right one for you?

As you can see, there are many benefits and limitations with either the revocable vs the irrevocable trust. Determining which type of trust is right for your situation is an important decision. Create your financial dream team comprised of your financial advisor, accountant and a reputable estate planning attorney to discuss your needs. They can help you create a plan to achieve your estate planning and financial goals.

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