Revocable vs. Irrevocable Trusts – The Must Know Differences

Revocable vs. Irrevocable Trusts – The Must-Know Differences By Attorney Paul Hanks of Ironclad Living Trusts

My law firm receives many inquiries regarding Revocable vs. Irrevocable trusts. This insider’s guide covers the many differences between Revocable vs. Irrevocable trusts.

Understanding Revocable Living Trusts

With a revocable living trust the trust creator retains full control over their assets and can freely move assets in and out of trust. The revocable trust avoids probate and insulates the estate from Medi-Cal estate recovery. A revocable living trust even protects the trust creator from loan fraud by reason of the retitling of the home into trust. A revocable living trust is a very flexible and powerful document, but it does not provide liability protection as does an irrevocable trust. Nor does it favorably impact Medicaid benefits. The revocable living trust is the prevailing choice of trust by about 95% of all our clients. Please read on for information on the other type of trust, that being irrevocable.

Benefits of Irrevocable Trusts

There are upsides that come with an irrevocable trust. It also avoids probate and is protective of loan fraud as does a revocable living trust. However, the irrevocable trust does come with a loss of control over the assets that the trust creator places into an irrevocable trust. The paradox is that the loss of asset control actually results in a few benefits of an irrevocable living trust that are not present with a revocable trust.

One such benefit is that since an irrevocable trust removes assets from your control, by creating and transferring your assets into an irrevocable trust, the trust creator is improving their chances of eligibility for Medicaid benefits, which can be important for long term care. When an irrevocable trust is created for this purpose, it is known as a Medicaid Asset Protection Trust.

The second additional benefit for an irrevocable trust is liability protection, but which is not as airtight as many people believe. Some individuals having creditor issues create an irrevocable trust to evade their debts, but the truth of the matter is that a judge can set aside that transfer. Many people are surprised to learn that the trustee under an irrevocable trust can be the subject of a lawsuit.

Estate Tax Considerations

The third benefit that is exclusive to an irrevocable trust relates to death and inheritance taxes. Most of us have no concern about the death tax for the reason that there are very favorable laws that insulate most estates from that tax. In another blog I alluded to the fact that the federal exemption shields most estates from the death tax. That exemption has largely eliminated the death tax and now stands at almost 14 million dollars for single persons and close to 28 million for married couples. However, if your wealth exceeds those limits then an irrevocable trust can serve as a legally appropriate vehicle to avoid taxation of the estate.

Downsides of Irrevocable Trusts

Besides the loss of control over your assets there are other downsides to an irrevocable trust. An irrevocable trust cannot be amended, and worse yet you are conveying legal title to your assets to the beneficiaries under that trust. The person creating an irrevocable trust cannot be the trustee (or manager) of the assets tucked into that trust.

Due to the reason of a loss of asset control under an irrevocable trust some people creating an irrevocable trust will name as trustee a family member who they control, which actually is a very high risk maneuver. You should never name someone as trustee under an irrevocable trust who you feel you can puppet and control. An irrevocable trust is high on the radar screen of the IRS and are often the subject of an IRS audit. From the time it is created an irrevocable trust must be assigned a federal tax identification. Annual tax returns must be filed in the name of the irrevocable trust.

Due to the many risks associated with irrevocable trusts this law firm recommends for an independent trustee to oversee and manage all property of the irrevocable trust. The independent trustee will also control a bank account in the name of the trust. With an irrevocable trust, the trust bank account is funded with money that used to belong to the trust creator. The trustee under the irrevocable trust and not you will control that bank account to service obligations tied to trust property and expenses of the trust.

And there are other shortcomings with an irrevocable trust. The trustee who you have appointed under an irrevocable trust can be sued in their capacity as trustee – an example would be if the irrevocable trust is funded with real estate and there is a lawsuit in relation to that property. Therefore, even with the presence of an irrevocable trust, it is very important to bind high limit insurance coverages.

Yet another downside to an irrevocable trust is that it negatively impacts the step up in tax basis on real property, which can expose a home to a future capital gains tax liability which otherwise would not have existed.

Making the Right Choice

Many people hastily create an irrevocable trust and then regret it. If you fail to pause and deliberate before creating an irrevocable trust, you could be harming yourself in many ways. An irrevocable trust is truly irrevocable. You cannot revoke an irrevocable trust as you could do so with a revocable trust. Indeed, it is often impossible to revoke an irrevocable trust. You should gather as much information as possible before deciding whether a revocable trust or an irrevocable trust is appropriate for your estate.

Would You Like a Free Consult With an Estate Planning Attorney?

If you wish to speak with an experienced estate planning lawyer, please contact us online or call us directly at (951) 587-3737. Ironclad Living Trusts is honored to  serve clients throughout all of Southern California.