Revocable vs. Irrevocable Trusts
In general, a trust is a separate legal entity that a person sets up to manage his or her assets. Trusts are set up during a person’s lifetime to assure that assets are used in a way in which the person setting up the trust deems appropriate. Once assets are placed inside a trust, a trustee manages them. The trustee determines how the assets are invested and to whom they are distributed.
The two basic types of trusts are a revocable trust and an irrevocable trust.
A revocable trust, a revocable living trust or living trust are all terms that describe the same thing. Essentially, the owner or Grantor of a revocable trust may change its terms at any time. The Grantor(s) may remove beneficiaries, designate new ones, and modify the trust in terms of to how manage assets within the trust. This is typically done with a trust amendment.
What can a Revocable Trust do?
A revocable trust allows the Grantor(s) to plan for mental disability. Assets held in the name of a revocable living trust at the time the Grantor(s) become mentally incapacitated can be managed by a successor trustee i.e. someone the Grantor(s) name to take over in the event he or she can no longer manage the trust.
Revocable trusts can also be used avoid probate of the assets they hold. These assets will pass directly to the beneficiaries named in the trust agreement. There is typically no need for probate court involvement.
Lastly, a revocable trust can protect the privacy of the property and beneficiaries when the Grantor(s) pass away. Because it’s not typically subject to probate, the trust agreement remains a private document. It doesn’t become a public record for the entire world to see. The assets within the revocable and the distribution of the assets will remain a private family matter.
Why aren’t all trusts revocable?
The ability to alter a revocable or living trust seemingly at will is very appealing for persons wanting to provide some protection to their personal assets. However, because all assets transferred to the trust are still considered the Grantor(s) personal assets a revocable trust typically offers little creditor protection if sued. Further, trust assets in revocable trusts are considered to be owned by the Grantor(s) for Medicaid planning purposes and may lead to Medicaid ineligibility. Lastly, when the Grantor(s) of a revocable trust dies, the assets held in trust are also subject to both state and federal estate taxes.
Typically, an irrevocable trust describes a trust that cannot be altered or modified after its creation. Except under exceedingly rare circumstances and with the consent of the beneficiaries may changes be made to an irrevocable trust. The Grantor(s), having transferred assets into the trust, effectively removes all rights of ownership to the assets and usually all control of the assets as well. Irrevocable trusts can take on many forms and can be used to accomplish a variety of estate planning goals.
What can an Irrevocable Trust do?
The main reason to select an irrevocable trust structure is taxes. Irrevocable trusts remove the assets from the Grantor’s taxable estate, meaning they are not subject to estate tax upon death. An irrevocable trust will also relieve the Grantor(s) of the tax responsibility for any income generated by the assets within the trust.
Another common use for an irrevocable trust is to provide asset protection for the Grantor(s). This works very similarly to the way that an irrevocable trust can be used to reduce estate taxes.
By placing assets into an irrevocable trust, the Grantor(s) give up control over and access to the assets within the trust. The assets while no longer in control of the Grantor(s), will also deny access to the Grant(s) creditors because the Grantor(s) no longer owns the assets. Further, this means that such assets are no longer considered an available resource for Medicaid and thus increases the Grantor(s) ability to qualify for Medicaid benefits.
However, the Grantor(s) can name family as beneficiaries of the irrevocable trust. The irrevocable trust can be set up in such a way as to allow the Grantor(s) to still be provided for and keep the assets outside of the reach of creditors.
Trusts are governed by both state and federal law. These laws change periodically and a tax professional or an attorney should be consulted for the most up-to-date advice.
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