Revocable vs. Irrevocable Trusts: Making the Right Choice for Your Estate Plan

When it comes to estate planning, trusts are powerful tools that provide security and control over your assets, ensuring they are distributed according to your wishes. After assets are transferred into a trust, a designated third party, referred to as the trustee, takes charge of their management. The trustee is responsible for making investment decisions for the assets and deciding how they will be distributed when the trust owner passes away. The trustee must adhere to the specific instructions outlined when the trust was originally created. One of the biggest questions are firm receives has to do with revocable vs irrevocable trusts and which is best.

In California, two of the most common trust options are the revocable trust and the irrevocable trust. Each has its own set of advantages and disadvantages, and choosing the right one is a crucial decision in the estate planning process. 

In this guide, we’ll break down the key differences between revocable and irrevocable trusts to help you make an informed choice for your unique situation.

What is a Revocable Trust?

A revocable trust, often referred to as a living trust, is a flexible estate planning tool. With a revocable trust, you retain control over your assets during your lifetime. You can make changes or amendments, or even revoke the trust entirely if your circumstances change. 

Advantages of a Revocable Trust

• Flexibility: You can modify or dissolve the trust at any time, allowing you to adapt to changing life circumstances.
• Probate Avoidance: Assets held in a revocable trust typically avoid probate, ensuring a smoother and more private transition of your assets to your beneficiaries.
• Privacy: Unlike wills, which become public record during probate, the terms of a revocable trust remain private.
• Act as Trustee: With a revocable trust, you can act as your own trustee and have a successor trustee handle your affairs in case you are incapacitated.

Disadvantages of a Revocable Trust

• No Asset Protection: A revocable trust does not provide protection from creditors or lawsuits.
• Estate Tax: Assets in a revocable trust are still considered part of your estate for estate tax purposes.
• Limited Medicaid Planning: It may not be suitable for Medicaid planning due to its revocable nature.

What is an Irrevocable Trust?

An irrevocable trust is a trust that, once created, cannot be altered or revoked without the consent of the beneficiaries. It offers strong asset protection and can have tax benefits. 

Advantages of an Irrevocable Trust

• Asset Protection: Assets placed in an irrevocable trust are typically shielded from creditors and lawsuits, providing enhanced asset protection.
• Tax Benefits: Certain irrevocable trusts can offer tax advantages, such as reducing estate taxes and protecting assets from capital gains tax.
• Medicaid Planning: Irrevocable trusts can be a useful tool for Medicaid planning, allowing you to qualify for benefits while preserving assets for your heirs.

Disadvantages of an Irrevocable Trust

• Loss of Control: Once assets are placed in an irrevocable trust, you surrender control over them, including the ability to make changes.
• Complexity: Irrevocable trusts can be more complex to set up and manage than revocable trusts.
• Limited Flexibility: Modifications to an irrevocable trust can be challenging and may require court approval.
• Higher Tax Rates: Irrevocable trusts often face substantial taxation, making it vital for the trustee to promptly distribute trust income to the beneficiary. Allowing income to accumulate within the trust can result in taxation at a higher bracket.

Key Differences Between Revocable and Irrevocable Trusts

The key differences between a revocable trust and an irrevocable trust lie in their flexibility, control, and purpose:

• Control and Flexibility

Revocable Trust: With a revocable trust, the grantor (the person who establishes the trust) retains full control and can make changes, amendments, or even revoke the trust entirely during their lifetime. They can also serve as the trustee, managing the trust assets themselves.

Irrevocable Trust: An irrevocable trust, once established, typically cannot be changed or revoked without the consent of the beneficiaries. The grantor relinquishes control over the assets placed in the trust, which can offer more asset protection.

• Asset Protection

Revocable Trust: Revocable trusts do not provide significant asset protection. The assets within a revocable trust are generally considered part of the grantor’s estate and are subject to estate taxes and claims from creditors.

Irrevocable Trust: Assets placed in an irrevocable trust are typically shielded from the grantor’s estate, reducing potential estate taxes. These assets are also protected from most creditors’ claims, providing better asset protection.

• Medicaid Planning

Revocable Trust: Medicaid considers the assets in a revocable trust as countable assets when determining eligibility for long-term care benefits. This can affect Medicaid qualification.

Irrevocable Trust: An irrevocable trust, structured correctly and funded appropriately, can help protect assets from Medicaid spend-down requirements, potentially preserving assets for heirs while still qualifying for Medicaid benefits.

Which Trust Type Is Best for You?

The choice between a revocable and irrevocable trust depends on your specific goals and circumstances. Here are some factors to consider:

• Asset Protection: If protection from creditors and lawsuits is a top priority, an irrevocable trust is generally the better choice.
• Estate Tax Planning: If you have a substantial estate and wish to minimize estate taxes, certain types of irrevocable trusts can be advantageous.
• Flexibility: If you desire flexibility and the ability to make changes to your estate plan as circumstances evolve, a revocable trust may be more suitable.
• Medicaid Planning: For those considering Medicaid planning, irrevocable trusts can help you qualify for benefits while preserving assets for your heirs.
• Complexity: Consider your comfort level with managing a potentially more complex trust structure.

FAQs

1. Who needs to build a trust?

Trusts are valuable tools for anyone seeking to ensure the efficient and private distribution of their assets, protect their assets, and minimize taxes.

2. How do I decide between a revocable and irrevocable trust?

Your choice should align with your goals. If you value control and flexibility, a revocable trust may be suitable. For asset protection and tax planning, an irrevocable trust could be the better option.

3. What are the main parties involved in an irrevocable trust?

In an irrevocable trust, you typically have a grantor (the person creating the trust), a trustee (the person managing the trust), and beneficiaries (those who will receive the trust’s assets).

4. Can a revocable trust become irrevocable?

Yes, it is possible to convert a revocable trust into an irrevocable trust, but it’s a complex process that requires careful consideration and legal guidance. 

In most cases, a revocable trust transitions into an irrevocable trust upon the grantor’s death. Following this event, the trust becomes unalterable, and its assets are managed in accordance with the predetermined terms outlined in the trust document.

Choosing between a revocable and irrevocable trust is a significant decision in your estate planning journey. It’s essential to consult with experienced estate planning professionals like us at Hermance Law to assess your unique needs and goals. 

With our guidance, you can make an informed choice that secures your legacy and protects your loved ones. Don’t wait; take the first step in planning your estate today. Contact us for a personalized consultation and let us help you build a secure future.