Filed Under:Life Insurance, Life Products

Revocable vs. irrevocable: Which trust is right for your client?

Living trusts tend to come in two basic flavors: revocable and irrevocable. Most clients will instinctively favor the revocable version. After all, why should they want to put their money into something they can never change, when they could put it into something they retain control over — and can even cancel altogether — instead?

Obviously, there must be good reasons to opt for the irrevocable variety. Not being able to revoke the trust is part of a trade-off that comes with several other benefits. The simplest difference between the two is that assets remain in the grantor’s estate in a revocable trust but move out of the estate in an irrevocable trust. The primary reasoning behind the irrevocable trust is that there are many good reasons for clients to want to move assets out of their estate.

Here are some simple ways to explain to your clients what they’re gaining by going with the irrevocable trust:

Asset protection. In a revocable trust, the grantor maintains ownership of the assets, so there’s always the potential to lose them to creditors or lawsuits. An irrevocable trust moves those assets out of the trustmaker’s hands, and the grantor is no longer considered to own them. An independent trustee makes all the decisions regarding investments on behalf of all the trustees, which may or may not include the grantor.

Avoiding capital gains taxes. There are ways to move assets into the irrevocable trust in such a way that they won’t incur capital gains taxes. That’s not possible with a revocable trust. (Keep in mind, though, that transferring assets through an irrevocable trust may result in gift taxes being owed.)

Avoiding estate taxes. The assets in a revocable trust remain in the grantor’s estate, so if they’re close to qualifying for the federal estate tax, those assets could easily push them over the limit. With an irrevocable trust, those assets are no longer part of the grantor’s estate.

Charitable giving. If assets are put into an irrevocable charitable trust while the grantor is still alive, the trustmaker can take a charitable income tax deduction for those assets. If the initial transfer of assets into such a trust doesn’t take place until after the trustmaker’s death, the estate will receive a charitable estate tax deduction.

See also: Leaving a phoenix-like legacy

Protecting assets from nursing homes. One important concern to keep in mind with a revocable trust is that those assets are still exposed to nursing homes. If a client ends up needing long-term nursing care, the money in a revocable trust that was intended to be left as part of an estate can be used for those bills instead.

At the same time, some people end up being too clever by half by pushing assets into an irrevocable trust, thinking they will be safe there, and nursing homes or other long-term-care facilities won’t be able to touch that money. Too many people end up needing the assets they’ve given to an irrevocable trust — and can’t get them back because the owners of the trust have died, or are going through a difficult divorce, or otherwise can’t afford to sacrifice those assets for the original trustmaker.

So what benefits does a revocable trust have, aside from the obvious one that the grantor can revoke it? Many grantors create a revocable trust to avoid probate, which it certainly does, but an irrevocable trust accomplishes that as well.

A revocable trust specifically works well for a client who doesn’t have serious tax issues, but wants to maintain control of his or her assets. But there’s one other scenario in which they can make a lot of sense: for a client who fears he or she will eventually be mentally incapacitated, whether that’s because of family history or for some other reason.

If the grantor of a revocable trust becomes incapable of managing his or her affairs, the designated trustee steps in to handle the assets. The trust can even set forth specific steps and guidelines that the successor trustee must carry out.

That, then, might be the ideal candidate for a revocable trust: a client who wants to maintain control over his or her assets, right up until the moment he or she can no longer mentally handle the job, at which point a designated trustee is ready to step in. In most other instances, the irrevocable trust makes more long-term financial sense.

 

For more estate planning tips, see:

BMO: More communication is needed in estate planning

Why contingent beneficiaries shouldn't be an afterthought

The clock is ticking on GRATs

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