A trust is an estate planning tool that you may consider using if you want to go beyond drafting a last will and testament. One key thing to decide is whether to establish a revocable or irrevocable trust. Both have their pros and cons and one may be more appropriate than the other, depending on your financial situation and needs. If you’re thinking of adding a trust to your financial plan, it helps to know how the two compare and which situations might suit them more optimally.
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Before taking a closer look at revocable and irrevocable trusts, it helps to know what a trust is. In simple terms, it’s a legal entity that allows you to transfer assets to the ownership of a trustee.
A living trust can be revocable or irrevocable. You can act as your own trustee or name someone else to do the job. A trustee – whether it’s you or someone else – assumes a fiduciary role, meaning that they’re required to act in the best interests of the trust beneficiaries.
Beneficiaries are the people you name to benefit from the trust. So, for example, you might set up a trust fund for the benefit of your spouse or children. When you create the trust document, you can spell out exactly how you want the assets in the trust to be managed and distributed to beneficiaries. It’s the trustee’s job to make sure your wishes are followed.
Not everyone needs a trust; for some people, a will may be sufficient. But if you have substantial assets that you plan to pass on, either to your family members or as part of a charitable giving plan, a trust can make doing so easier.
There are many different types of trusts you can establish. For example, there are grantor trusts, A/B trusts, testamentary trusts, special needs trusts – but they all have one thing in common. All of these trusts are either revocable or irrevocable.
Simply, it’s a trust that can be changed or terminated at any time during the lifetime of the grantor (i.e., the person making the trust). So that means you could:
A revocable trust is known as a living trust. When you pass away, a revocable trust automatically becomes irrevocable. That means no further changes can be made to its terms.
An irrevocable trust is essentially permanent and it cannot usually be changed for any reason. If you set up an irrevocable trust during your lifetime, any assets you transfer to the trust would have to remain in the trust. You couldn’t add or remove beneficiaries or change the terms of the trust.
There are numerous types of irrevocable trusts:
Each type of irrevocable trust is either a testamentary trust or a living trust. A testamentary trust is created in a last will and testament and comes into existence only after the settlor dies. Because a testamentary trust doesn’t take effect until after the settlor dies, he or she can make changes up until death, at which point the trust becomes irrevocable. The trust won’t transfer assets outside of probate since the grantor owns the assets at the time of death.
The main advantage of choosing a revocable trust is flexibility. A revocable trust allows you to make changes, whereas an irrevocable trust does not. That’s helpful if you’re concerned about your financial situation or needs changing at some point and you want to make sure your trust can still meet those needs.
A revocable trust can also offer peace of mind if you’re worried about becoming incapacitated and not being able to manage your assets. As long as your trust document is clear on what you want, then your trustee is bound to follow your wishes. Revocable trusts can also allow your heirs to bypass probate once you pass away.
One downside is that a revocable trust doesn’t offer the same type of protection against creditors as an irrevocable trust. So if you’re sued, creditors could still attempt to attach trust assets to satisfy a judgment.
Also, assets in a revocable trust are part of your taxable estate, meaning they are subject to federal estate taxes when you die. Federal estate taxes are due for any amount above the current exemption, which in 2024 is $13.61 million for individuals and $27.22 million for married couples.
An irrevocable trust can have its benefits but there are also some dangers to keep an eye on before deciding to move forward. Here are the most common pros and cons of an irrevocable trust:
In addition to protecting assets from creditors, irrevocable trusts can also come in handy for managing estate tax obligations. From a tax standpoint, assets are owned by the trust, not you, which makes it possible to sidestep estate taxes. Holding assets in an irrevocable trust can also be useful if you’re trying to qualify for Medicaid to help pay for long-term care and want to avoid having to spend down assets.
The downside of irrevocable trust is that you can’t change it. And you can’t act as your own trustee either. Once the trust is set up and the assets are transferred, you no longer have control over them, which can be a huge danger if you aren’t confident about the reason you’re setting up the trust to begin with.
Whether a revocable or irrevocable trust will work better for your estate plan depends on what you need a trust to do for you.
A revocable trust might be preferable when,
An irrevocable trust might be preferable when,
Talking with an estate planning attorney can help you decide whether a revocable or an irrevocable trust is best or whether you even need a trust at all. From there, you can further explore the different trust options you can set up to manage your assets.
Revocable and irrevocable trusts can serve different purposes in an estate plan. They can be used alongside a last will and testament to make sure your wishes are followed. When considering a trust, think about what you need it to do for you and your beneficiaries in the short- and long term.
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Rebecca Lake, CEPF®Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children. Rebecca also holds the Certified Educator in Personal Finance (CEPF®) designation.
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