There are two primary types of trusts – revocable and irrevocable. Here are the basics regarding the differences between them and the benefits each has to offer.
What is a Revocable Trust?
A revocable trust is a trust in which the provisions can be altered or canceled by the grantor. During the lifetime of the grantor, the income earned by the trust is distributed to the grantor and it is only after the death of the grantor that the property is transferred to the beneficiaries.
Benefits of a Revocable Trust
One situation where a revocable trust is an excellent choice is when an individual does not have any major tax issues and wants to maintain control over his or her assets.
Another situation where a revocable trust makes a lot of sense is where the individual is concerned that he or she will eventually become mentally incapacitated and no longer able to make his or her own decisions. A designated trustee would step in to handle the revocable trust and make all necessary decisions when the individual does become mentally incapacitated. This allows the individual to determine whom they want to make their decisions and handle their finances, leaving specific instructions for the trustee to follow.
What is an Irrevocable Trust?
An irrevocable trust is a trust that cannot be changed, amended, or terminated without the beneficiary’s permission. Once the assets are transferred into the trust, the grantor cannot change the terms. In other words, the grantor loses all rights of ownership to those assets.
Benefits of an Irrevocable Trust
There are many benefits to putting assets into an irrevocable trust, including:
Protection of Assets
The grantor no longer has rights of ownership to the assets, so the grantor’s creditors can no longer reach the assets because he or she no longer owns them. A designated trustee handles all decisions regarding the asset on behalf of the beneficiaries.
Avoid Capital Gains Taxes
It is possible to transfer assets to an irrevocable trust in a manner that avoids paying capital gains taxes. That is not possible with a revocable trust.
Avoid Estate Taxes
Assets in an irrevocable trust now belong to the trustee and the beneficiaries of the trust. The assets are no longer a part of the grantor’s estate and therefore are not subject to estate taxes when he or she passes away.
Assets put into an irrevocable trust such as charitable remainder trust or a charitable lead trust while the grantor is still alive allows the grantor to take a charitable income tax deduction for those assets in the year the transfer was made. If the initial transfer of assets into a charitable trust occurs after the grantor’s death, the estate will receive a charitable estate tax deduction instead.
Protect Assets from Nursing Homes
Assets in an irrevocable trust cannot be utilized as an available resource for Medicaid planning and cannot be taken out by nursing homes to pay the bills. One thing to watch here, though, is if money does become an issue in the future you cannot change your mind and take your assets out of the irrevocable trust to pay your bills.
Both state and federal laws govern all trusts. These laws change periodically so it is important to consult a tax professional or an attorney for advice before transferring assets into either a revocable or irrevocable trust.