What's the Difference Between a Revocable and an Irrevocable Trust?
The column dealt mainly with setting up irrevocable trusts, leading reader Rey Barry to ask, "Why was there no mention of revocable family trusts?" So let's look at the differences between these two types of trusts.
The biggest distinction is that an irrevocable trust cannot be changed or revoked once you create it, as its name implies. A revocable trust can be changed as often as you like while you're still alive.
An irrevocable trust usually is created to remove assets and their future income and appreciation from your estate. Once you put assets into an irrevocable trust, you relinquish your rights to these assets. The good part is that they are now out of your estate. That means these assets will not be subject to estate tax, says Laura Peebles, director of estates, gifts and trusts at Deloitte & Touche in Washington. But by giving those assets to a trust, you may be liable for gift tax.An irrevocable trust "protects your assets from ex-spouses or spendthrift grandchildren," says Peebles. In addition, your beneficiary's creditors can't touch assets in an irrevocable trust. It's a great vehicle for having your plans carried out without having to worry about your assets falling into the wrong hands. A revocable trust also is called a living trust. The obvious difference is that you can amend, modify or cancel this trust at any time. It must be created while you are still alive because it becomes irrevocable after you're dead. Putting the assets in a revocable trust does not get them out of your estate. You'll pay estate tax on these assets, but you won't pay gift tax. That means any income or appreciation generated from these assets flows back to you, so you will owe income tax on that money. So there are no real income or estate tax advantages to this, notes Peebles. The big perk to a revocable trust -- as with most trusts -- is the privacy. When you die, your will becomes public record. So your beneficiaries will know exactly what they're getting -- or, more importantly, what they're not getting -- from you and your estate. "If you're Celine Dion, you don't want the National Enquirer getting its hands on your will," notes Peebles. But you don't have to be a big star to want some privacy. In a revocable trust, you control the flow of assets to whomever you want without the whole world knowing. Only your appointed trustee has to know your plans for your beneficiaries. The other advantage is that the trust will help you avoid probate fees in some states. When you die, your will must go through probate, a special legal proceeding. Some states charge exorbitant fees for these proceedings. Transferring your assets to a revocable trust can cut those probate costs because the assets in the trust are not controlled by your will. "Just make sure that your will and the revocable trust are coordinated," reminds Peebles. So think of a revocable trust as a private will that may allow you to escape some probate processing fees. "But these trusts are not 'one size fits all,'" says Peebles. "Not everybody needs one." In some instances, a will may be all you need. Note that a revocable trust can't take the place of a will because you can't name a guardian for kids, for one.
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