What’s the Difference between Revocable and Irrevocable Trusts?
Written by Jim Worthington on October 21, 2018
The simplest way to explain the difference is that a revocable trust is one you can change and an irrevocable trust is one you can’t change. To be more precise, an irrevocable trust is one you can’t change easily. In states like Kentucky that have adopted the Uniform Trust Code, procedures exist to reform an irrevocable trust, but the details of those are beyond the scope of this article. Moreover, one shouldn’t count with 100% certainty on being able to change an irrevocable trust.
As discussed in an earlier post, revocable trusts are sometimes used as will substitutes to avoid probate. As with a will, the person who creates the trust can amend it as long as he or she is competent to do so.
Why would somebody want to make an irrevocable trust if it can’t easily be changed?
Irrevocable trusts can be used to remove assets from one’s estate to save on taxes or for a specified purpose as well as to protect assets from other peoples’ creditors. (It is possible in some states to use trusts to protect one’s own assets from creditors.)
How does an irrevocable trust save taxes?
Irrevocable trusts save estate taxes by removing assets from one’s taxable estate. While the transfer to the trust may be subject to gift tax, any growth will not be subject to estate tax.
What are other reasons to remove assets from one’s estate?
One may want to make gifts for education of children or grandchildren. Trusts can be created under Section 2503(c) of the Internal Revenue Code to allow gifts to be held in trust until a person’s, i.e., the trust beneficiary’s, 21st birthday. If the trust beneficiary agrees, the trust can last even longer.
How does an irrevocable trust protect assets?
One can give assets—as a gift during lifetime or as an inheritance at death—in a trust that protects the assets from the recipient’s creditors. The best way to protect the assets is to select an independent trustee such as a bank or trust company and to give it broad discretion to make distributions to the beneficiary. That discretion must be so broad that the trustee can refuse to make distributions. That way, if the beneficiary’s creditors try to reach the trust assets, the trustee simply declines to make a distribution.
This information about irrevocable trusts scratches the surface. Lawyers spend a lifetime refining their skills at drafting irrevocable trusts. Because irrevocable trusts can’t be changed easily, it is important to take the time to design them for as many scenarios as possible. It is much more certain and much less expensive to do that work on the front end than to pursue a change later on.