How much control do you need? Revocable v irrevocable trusts

What’s the difference between a revocable and an irrevocable trust? As an attorney, I often hear this question, usually with the person who’s asking adding something along the lines of: I know what the words mean, but what are the implications for each?

Simply put, what distinguishes the two is how much control you retain over your assets. But then, once you reach a certain level of wealth, things get complicated, and we’re also talking about taxes and how to avoid paying them.

One of the most common tools in estate planning, revocable living trusts are characterized by their flexibility. While you as the person who created the trust, aka the grantor, formally transfer property into it, you de facto still own the assets and can therefore change or even dissolve the trust at any time, no questions asked. Once you die, your revocable trust becomes irrevocable. Your trustee takes over until she has distributed the assets to your heirs, and that’s the end of the trust.

Revocable trusts work perfectly in achieving two goals: They serve as a safety net should you become incapacitated and no longer be able to manage your own assets, and they help avoid probate. (See one of my earlier posts, The low down on probate and how to avoid it, for more details on this topic.)

The limitations of a revocable trust? The instrument will and cannot help you save taxes. Since you still own the assets in question, the state and the federal governments will levy the same taxes as they do on assets outside of a trust.

Irrevocable trusts are a whole different game. With this tool, you relinquish ownership of your assets and thereby gain tax advantages even if your wealth exceeds the federal estate tax exemption limit. (For 2014, the limit was set at $5,340,000.) An irrevocable trust can also help protect your property from creditors who might want to go after it, and it can be a nice tax saving tool for philanthropists.

Irrevocable trusts come in a number of varieties, some of them with admittedly obscure names. To list a few, there are charitable and life insurance trusts, disclaimer and credit shelter trusts, QTIP and generation skipping trusts. Each of these is useful in its own way, but I’ll talk more about the details in future posts. For now a fair warning: Irrevocable trusts are a complex matter, and I advise you to seek professional guidance for creating them.

by Kevin J. Moore