Understand the difference and the uses for each
What is a trust?
A trust is a fiduciary arrangement that allows you to transfer assets from your direct ownership to an entity governed by a trustee on behalf of the trust’s beneficiaries. Trusts are commonly used in estate planning strategies to:
- Minimize estate taxes
- Control your wealth through prescriptive terms within the trust
- Protect your wealth from creditors or complex family dynamics
- Maintain privacy for your estate and avoid probate costs
The document that governs a trust is drafted by an estate planning attorney based on the specifications of your estate plan. A vital role within a trust structure is the trustee. A trustee assumes a fiduciary role which means they are required to act in the best interests of the trust beneficiaries. The beneficiaries are the people that you will name to benefit from said trust.
Trusts can be set up in many ways but commonly fall under the categories of revocable or irrevocable trusts. There are differences between revocable and irrevocable trusts that make them advantageous for various functions within a well- crafted estate plan. We will review the pros and cons of each type of trust and why individuals may use them within their estate plan.
What are the significant differences between Revocable and Irrevocable Trusts?
All trusts are either revocable or irrevocable. The main difference between revocable and irrevocable trusts is whether the trust can be modified once executed.
A revocable trust is a trust that can be changed or terminated at any time during the lifetime of the grantor (i.e., the person making the trust). Some examples of changes a grantor may seek to make are:
- Adding or removing beneficiaries at any time
- Transferring new assets into the trust or remove ones that are already in it
- Changing the terms of the trust concerning how assets should be managed ordistributed
- Terminating the trust completely
A revocable trust automatically becomes irrevocable once you pass away. That means no further changes can be made to its terms. Conversely, an irrevocable trust is essentially permanent once it is executed. So, 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 would not be able to add or remove beneficiaries or change the terms of the trust once the trust is put in place.
Another important difference is in the ownership of property held in the trust. Within a revocable trust, since the trust can be changed at any time, the property held in the trust is still legally considered property of the grantor. Whereas property transferred to an irrevocable trust becomes legal property of the trust and is no longer owned by the grantor.
A final key difference is the treatment of assets within your estate. As mentioned previously, an irrevocable trust legally transfers ownership of property from the grantor to the trust. This allow the property to be removed from your taxable estate upon death. While a revocable trust will help to bypass probate, it will not remove assets from your taxable estate.
Revocable Trust Pros and Cons
If you are concerned about your financial situation or believe that the trust will need changing in the future, a revocable trust would most likely be preferable. This type of trust offers more flexibility and allows changes to be made when required. They also allow your heirs to bypass probate once you pass away.
A potential downside is that a revocable trust does not offer the same protection against creditors as an irrevocable trust. This means that if you are sued, creditors can still attempt to attach trust assets to satisfy a judgment. Additionally, revocable trusts will not remove assets from your taxable estate.
Irrevocable Trust Pros and Cons
Irrevocable trusts can come in handy for managing estate tax obligations. From a tax standpoint, assets are owned by the trust and not you, which makes it possible to sidestep estate taxes. An irrevocable trust can also be helpful if you are trying to qualify for Medicaid to help pay for long-term care and want to avoid having to spend down assets.
As previously stated, the downside to this type of trust is that you are unable to change them, and you cannot act as your own trustee either. Once assets have been transferred over, you will no longer have control over them.
Another potential downside of an irrevocable trust is that the trustee needs to be someone who is not considered an “alter-ego.” This means anyone from your direct relatives to any agent of yours (i.e., your attorney or accountant).
It is crucial to create and fund irrevocable trusts far in advance of when you think you may need asset protection, as the court may find a transfer invalid if the trust is created not long before the creditor receives a judgment against you.
One of the main reasons to select an irrevocable trust is that these types of trusts remove the assets from the benefactor’s taxable estate, which means that they are not subject to estate tax upon death. They also relieve the benefactor of tax responsibility for any income generated by the assets.
Final Thoughts
A well-crafted estate plan may include both revocable and irrevocable trusts to accomplish the intentions of your wealth transition goals. We at Shepherd Financial Partners are believers that estate and wealth transition strategies should be considered within the broader context of your financial plan so that results can be optimized. We will work with your family to discuss your current goals and the vision you have for how your resourced can benefit future generations.
Disclosures:
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All indices are unmanaged and may not be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performances not indicative of the performance of any investment.
Past performance is no guarantee of future results.
Investment advice offered through Shepherd Financial Partners, LLC, a registered investment advisor. Registration as an investment advisor does not imply any level of skill or training.
Securities offered through LPL Financial, member FINRA/SIPC. Shepherd Financial Partners and LPL Financial are separate entities.
Additional information, including management fees and expenses, is provided on Shepherd Financial Partners, LLC’s Form ADV Part 2, which is available by request.
This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation.
Tracking #: 1-05219289