Revocable Trust vs. Irrevocable Trust: What's the Difference?

Revocable Trust vs. Irrevocable Trust: An Overview

A revocable trust and living trust are separate terms that describe the same thing: a trust in which the terms can be changed at any time. An irrevocable trust describes a trust that cannot be modified after it is created without the beneficiaries' consent or court approval, and possibly both.

A trust is a separate legal entity a person sets up to hold their assets. Trusts are set up during a person's lifetime to assure that assets are used in a way that the person setting up the trust deems appropriate. Once assets are placed inside a trust, a third party, known as a trustee, manages them. The trustee determines how the assets are invested and distributes them when the trust owner dies. However, the trustee must manage the trust following the guidelines laid out when the trust was formed, including giving funds to the designated beneficiary or beneficiaries.

It's not uncommon for an individual to use a trust instead of a will for estate planning and stipulating what happens to their assets upon their death. Trusts are also a way to reduce tax burdens and avoid assets going to probate.

Revocable Trust (Living Trust)

The two basic types of trusts are a revocable trust, also known as a revocable living trust or simply a living trust, and an irrevocable trust. The owner of a revocable trust may change its terms at any time. They can remove beneficiaries, designate new ones, and modify stipulations on how assets within the trust are managed. Given the flexibility of revocable or living trusts in contrast with the rigidity of an irrevocable trust, it may seem that all trusts should be revocable.

However, there are a few key disadvantages to revocable trusts. Because the owner retains such a level of control over a revocable trust, the assets they put into it are not shielded from creditors the way they are in an irrevocable trust. If they are sued, the trust assets can be ordered liquidated to satisfy any judgment put forth. When the owner of a revocable trust dies, the assets held in trust are also subject to state and federal estate taxes.

If the beneficiaries of a revocable trust are young (not of legal age) and the minor's real estate assets are held within a trust, it can replace the need to appoint a conservator, should the grantor die. In addition, if a grantor names beneficiaries who they deem unreliable with money, the trust can set aside a specific amount to be distributed at recurring intervals, or when they come of age (if they are minors).

Irrevocable Trust

The terms of an irrevocable trust, in contrast, are set in stone the minute the agreement is signed. Except under exceedingly rare circumstances, no changes may be made to an irrevocable trust. Any alterations would have to be done by 100% consent of its beneficiaries or by order of the court, and in some cases both court approval and beneficiary consent may be required. The exact rules can depend on state laws.

The main reason to select an irrevocable trust structure is taxes. Irrevocable trusts remove the benefactor's taxable estate assets, meaning they are not subject to estate tax upon death. If the trust is a guarantor trust, the creator of the trust covers the income tax of trust assets, and the beneficiary will not owe income taxes on distributions. If the trust is not a guarantor trust, the trust pays income taxes on its assets while they are in the trust, and the beneficiary will owe income taxes on distributions. Irrevocable trusts can be difficult to set up and require the help of a qualified trust attorney.

If you work in a profession where you may be at risk for lawsuits, such as a medical professional or lawyer, an irrevocable trust could be helpful to protect your assets. When assets are transferred, whether they are cash or property, to the ownership of an irrevocable trust, it means the trust is protected from creditors, and even legal judgment. However, an irrevocable trust is a bit more complicated to set up than a revocable trust, namely because it cannot be altered.

Key Differences

There are some key differences between a revocable and an irrevocable trust beyond that a revocable trust can be altered but an irrevocable trust cannot be changed. It is more common for the guarantor to be a trustee or the trustee of a revocable trust. For an irrevocable trust, it is possible, but less common. Many attorneys advise against it as well.

Revocable Trust vs. Irrevocable Trust Example

Let us say an individual creates a revocable trust to benefit their family and protect their assets. In doing so, as the grantor of a revocable trust, they can also name themselves the trustee and the beneficiary of the trust. When they get older, they can go back into the trust and name a new beneficiary and add a trustee to step in if they become incapacitated in their more senior years.

The trust can be amended several times within the trustee's lifetime, say if the trustee remarries or after the birth of a grandchild. When they pass, their trust is kept out of probate, and the stipulations in their trust can be carried out discreetly.

The disadvantages, however, are it can be costly to write one up and even more expensive if you make alterations numerous times. A trust must be funded, and assets must be moved into the trust, which can also have some costs.

Now, let's say the same individual creates an irrevocable trust to benefit their family and protect their assets. Instead of naming themselves the trustee and beneficiary, the grantor would usually designate a separate trustee and feel secure giving up ownership and controlling assets, such as property. They will now have to carefully vet a trustee and a trust protector who acts as an oversight manager of the trust. Then, they must name beneficiaries. Once assets have been put into an irrevocable trust, unlike a revocable trust, the grantor now must let it rest, as they cannot alter the trust without significant difficulty.

Under certain circumstances, the inability to change the trust makes an irrevocable trust potentially a risky endeavor. It is difficult to change the named beneficiaries in an irrevocable trust. And the grantor may not be able to access their assets, even if a life event makes it necessary.

The Bottom Line

Trusts are legal entities that a person sets up to hold their assets. A revocable trust has the advantage of flexibility in that it can be altered at any time by the grantor who sets it up. However, it has disadvantages, too. A revocable trust doesn't shield the grantor's assets from creditors, which means if the grantor is sued, the trust assets can be ordered liquidated to satisfy a judgment. Also, when the owner of a revocable trust dies, the assets held in trust are subject to state and federal estate taxes. By contrast, an irrevocable trust cannot be changed except under extremely rare circumstances. It also shields assets from creditors in lawsuits, and assets are not subject to estate taxes. But irrevocable trusts are complicated to set up. If you're thinking of establishing one, consult a qualified trust attorney.