Trusts are a common element of an estate plan. In fact, most of our estate planning clients have at least one trust.
But it is important to know that not all trusts are the same. Your estate plan should be customized with the type of trust (or trusts) that’s right for your needs.
Generally, a trust is a legal arrangement you can use to manage your property and other assets before and after you pass away. Trusts help avoid a time-consuming and expensive probate process.
As the grantor of your trust, you transfer property and assets into the trust for the benefit of one or more individuals or entities — the beneficiaries. You also designate a trustee to manage the distribution of the trust assets when you pass away.
A trust can be revocable or irrevocable. So, what’s the difference between a revocable trust and an irrevocable trust?
Simply put, the answer can be boiled down like this:
Revocable Trust = You maintain control.
Irrevocable Trust = You give up control.
Digging in a little deeper, here are four key areas in which revocable and irrevocable trusts are different:
1. Control & Ownership: With a revocable trust, you retain full control and ownership of the assets placed in the trust during your lifetime. You can modify, amend, or revoke the trust at any time. After you pass away, your revocable trust becomes irrevocable, and the trustee distributes the assets based on your instructions.
On the other hand, with an irrevocable trust, you typically relinquish control and ownership rights over the assets placed in the trust and cannot make changes without the beneficiaries’ consent or if specific conditions are met.
2. Estate Taxes: The assets in a revocable trust are included in your taxable estate for estate tax purposes. When you die, that means they may be subject to federal and state estate taxes.
With an irrevocable trust, the assets are typically considered to be outside of your taxable estate, which might reduce estate taxes. But there could be gift tax implications when you create the irrevocable trust or contribute to it.
3. Asset Protection: A revocable trust does not offer you asset protection because the assets in the trust are considered part of your estate — meaning they are accessible to creditors and legal judgments.
An irrevocable trust provides asset protection because you no longer own the assets in the trust, which are instead held for the benefit of the beneficiaries and may be shielded from creditors.
4. Medicaid Planning: While a revocable trust doesn’t provide Medicaid planning benefits, certain kinds of irrevocable trusts, such as a Medicaid Asset Protection Trust, can be used to protect assets from being counted when determining eligibility for Medicaid benefits.
Overall, revocable trusts give you more control and flexibility but fewer asset protection and estate tax benefits, while irrevocable trusts offer greater asset protection and potential estate tax advantages but require giving up control over the assets.
Deciding which type of trust you need depends on your financial circumstances and specific estate planning goals. Consult with an estate planning attorney now to decide which type of trust is most suitable for you and get help creating it.