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Older couple considers which kind of trust would be best

A trust is an estate planning tool that you may consider using if you want to go beyond drafting a last will and testament. One key thing to decide is whether to establish a revocable or irrevocable trust. Both have their pros and cons and one may be more appropriate than the other, depending on your financial situation and needs. If you’re thinking of adding a trust to your financial plan, it helps to know how the two compare.

Consider working with a financial professional to incorporate estate planning into your financial plan. Find a financial advisor today.

What Is a Trust?

Before taking a closer look at revocable and irrevocable trusts, it helps to know what a trust is. In simple terms, it’s a legal entity that allows you to transfer assets to the ownership of a trustee.

A living trust can be revocable or irrevocable. You can act as your own trustee or name someone else to do the job. A trustee – whether it’s you or someone else – assumes a fiduciary role, meaning that they’re required to act in the best interests of the trust beneficiaries.

Beneficiaries are the people you name to benefit from the trust. So, for example, you might set up a trust fund for the benefit of your spouse or children. When you create the trust document, you can spell out exactly how you want the assets in the trust to be managed and distributed to beneficiaries. It’s the trustee’s job to make sure your wishes are followed.

Not everyone needs a trust; for some people, a will may be sufficient. But if you have substantial assets that you plan to pass on, either to your family members or as part of a charitable giving plan, a trust can make doing so easier.

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

There are many different types of trusts you can establish. For example, there are grantor trusts, A/B trusts, testamentary trusts, special needs trusts – but they all have one thing in common. All of these trusts are either revocable or irrevocable.

What is a revocable trust? Simply, it’s a trust that can be changed or terminated at any time during the lifetime of the grantor (i.e., the person making the trust). So that means you could:

  • Add or remove beneficiaries at any time
  • Transfer new assets into the trust or remove ones that are already in it
  • Change the terms of the trust concerning how assets should be managed or distributed
  • Terminate the trust completely

When you pass away, a revocable trust automatically becomes irrevocable. That means no further changes can be made to its terms.

An irrevocable trust is essentially permanent. If you set up an irrevocable trust during your lifetime, any assets you transfer to the trust would have to remain in the trust. You couldn’t add or remove beneficiaries or change the terms of the trust.

Revocable Trust Pros and Cons

The main advantage of choosing a revocable trust is flexibility. A revocable trust allows you to make changes, whereas an irrevocable trust does not. That’s helpful if you’re concerned about your financial situation or needs changing at some point and you want to make sure your trust can still meet those needs.

A revocable trust can also offer peace of mind if you’re worried about becoming incapacitated and not being able to manage your assets. As long as your trust document is clear on what you want, then your trustee is bound to follow your wishes. Revocable trusts can also allow your heirs to bypass probate once you pass away.

One downside is that a revocable trust doesn’t offer the same type of protection against creditors as an irrevocable trust. So if you’re sued, creditors could still attempt to attach trust assets to satisfy a judgment.

Irrevocable Trust Pros and Cons

In addition to protecting assets from creditors, irrevocable trusts can also come in handy for managing estate tax obligations. From a tax standpoint, assets are owned by the trust, not you which makes it possible to sidestep estate taxes. Holding assets in an irrevocable trust can also be useful if you’re trying to qualify for Medicaid to help pay for long-term care and want to avoid having to spend down assets.

The downside to irrevocable trusts is that you can’t change them. And you can’t act as your own trustee either. Once the trust is set up and the assets are transferred, you no longer have control over them.

Revocable vs. Irrevocable Trusts: Which Is Better?

Whether a revocable or irrevocable trust will work better for your estate plan depends on what you need a trust to do for you. If your chief goals are to minimize taxes and protect assets from creditors, then an irrevocable trust might be the more appropriate option. On the other hand, if you just want a legal way to make sure your assets are managed according to your wishes during your lifetime and beyond, you might choose a revocable trust instead.

Talking with an estate planning attorney can help you decide whether a revocable or an irrevocable trust is best or whether you even need a trust at all. From there, you can further explore the different trust options you can set up to manage your assets.

Benefits of Trusts for Estate Planning

There are three chief benefits associated with including a trust as part of an estate plan.

1. Avoiding probate

Probate is a legal process in which your assets are inventoried after you pass away, any debts owed by your estate are paid and any remaining assets distributed to your heirs according to your will or state law if you die intestate. Probate can be time consuming and costly for your heirs. Assets held in a trust can avoid probate, which can save your heirs time and money.

2. Protection from creditors

Transferring assets to a trust can also offer a layer of protection against creditors, depending on what type of trust you’ve established. While creditors can attempt to attach assets held outside a trust, those inside it can’t be accessed to pay outstanding debts.

3. Minimize estate tax

Estate taxes can take a big bite out of the wealth you may be planning to leave behind for your spouse, children or grandchildren. Including assets in a trust may help to minimize the impact of estate and inheritance taxes, preserving more of your wealth for future generations.

The Bottom Line

A multi-generational familyRevocable and irrevocable trusts can serve different purposes in an estate plan. They can be used alongside a last will and testament to make sure your wishes are followed.

When considering a trust, think about what you need it to do for you and your beneficiaries in the short- and long-term.

Tips for Estate Planning

  • Consider talking to your financial advisor about incorporating trusts and other estate planning tools into your financial plan. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • There are certain things a will can do that a trust can’t, so it’s important to make sure you’re covering all the bases in your estate plan. For example, you can use a will to name legal guardians for minor children.

Photo credit: ©iStock.com/AlexRaths, ©iStock.com/designer491, ©iStock.com/monkeybusinessimages

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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