If you’re looking into estate planning, understanding the difference between revocable and irrevocable trusts is vital to your family’s future. If you select the option that doesn’t align with your goals, you could end up with considerable tax and legal penalties.
In most cases, the revocable living trust will become irrevocable if the trustmaker dies, and it may be broken into separate, individual irrevocable trusts to benefit the surviving family members. This is usually referred to as AB trusts or ABC trusts.
Though the inability to modify an irrevocable trust can be unsettling to some, irrevocable trusts are used for different estate planning purposes, such as:
- Estate tax reduction: Irrevocable trusts can be used to take the value of assets from an estate and reduce the amount of taxes paid. In this case, the assets in an irrevocable trust are given to the trustee or beneficiaries, which means they no longer belong to the trustmaker and can’t be taxed.
AB trusts can be used for the same purpose, however. AB trusts are exempt from estate taxes when the funding of the B trust falls below the estate tax exemption. If the remaining value of the estate is higher than the estate tax exemption, the assets are transferred into the A trust, which benefits the surviving spouse and defers the estate taxes until after the death of the surviving spouse.
ABC trusts are often chosen by married couples who are subject to state estate tax, provided the state estate tax exemption is lower than the federal estate tax exemption. Like the AB trust, this allows the transfer of assets to lower the estate tax burden, but the C holds the difference between the federal and state tax exemption and defers the tax payment until after death.
So, what is the difference between revocable and irrevocable trusts? Learn more about each of these options and find out which one is more appropriate for your needs.
A revocable living trust, which may also be called a living trust, revocable trust or inter-vivos trust, is a trust that can be revised or altered at any point. If you’re considering estate planning early in your life, for example, a revocable living trust allows you to change the beneficiary or trustee if your situation changes. This is a trust amendment. You also have the option to rewrite the entire agreement if you choose, which can be done through a trust amendment and restatement.
While the option to revise your trust is appealing for many, there are a few disadvantages to choosing a revocable trust. The assets included in the trust are considered your assets for the sake of estate tax and debts, so there’s no credit protection against a lawsuit. All assets in your trust at the time of death are subject to federal and state estate taxes, as well as state inheritance taxes, and they factor in to the Medicare/Medicaid planning process.
Choosing a revocable living trust for your estate planning is the right choice if:
- You’re planning for mental disability. In this situation, a revocable living trust allows the assets within the trust to be handled by a disability trustee, rather than the court guardian, at the time of mental incapacitation.
- You want to avoid probate. At the time of your death, assets within a revocable trust can be distributed directly to the beneficiaries outside of probate.
- You want to protect your privacy. Because you avoid probate with a revocable trust, your agreement will stay private, unlike a will, which becomes public record. This protects the details of your property, assets and who you’ve named as beneficiaries, allowing your family’s business to remain private.
An irrevocable trust is a type of trust that can’t be amended or altered after it’s been signed. This can also apply to a revocable trust that has become irrevocable following the death of the trustmaker.
Under certain conditions, however, an irrevocable trust may be changed, such as when part of the trust agreement states that the terms may be modified under limited and specific circumstances. Charitable trusts can also be modified, and the court may order judicial modification of a trust if it’s petitioned to do so by a trustee or beneficiaries.
- Asset protection: Irrevocable trusts allow asset protection for the trustmaker. In a similar way to how an irrevocable trust may be used to reduce taxes, a trustmaker can transfer assets into an irrevocable trust. The trustmaker gives up control of the assets, which protects them from debts or other financial obligation.
In this situation, the family can become beneficiaries of the irrevocable trust to have the financial support, while also being protected from debt. These are known as self-settled trusts or domestic asset protection trusts. As you can see, there are many ways to create an irrevocable trust that benefits the surviving spouse or beneficiaries.
- Charitable estate planning: Irrevocable trusts can also be used for charitable estate planning, which can be done through a charitable remainder trust or a charitable lead trust. After the initial transfer of assets, the trustmaker earns a charitable income tax reduction for the year the transfer occurred. If this contribution is made after the trust maker’s death, the estate receives a charitable estate tax deduction.
Choosing a Trust in Estate Planning
There are many options in estate planning to ensure you protect your assets and distribute them to the family members and friends you desire, but choosing the one that best fits your needs depends on your individual goals and current assets.
Estate planning can be complicated, so if you want to be sure you’re making the right choice for your future goals, Tanko Law can help. Our experienced estate planning attorneys will be happy to help you learn more about the difference between revocable and irrevocable trusts and guide you through the advantages and disadvantages, giving you the tools you need to plan for the future. Contact us today to schedule a consultation and get started with the estate planning process!