Irrevocable vs. Revocable: Understanding the Two Major Categories of Trusts

While there are many types of trusts—and each serves various needs and purposes—all trusts fall within one of two major categories. They are either revocable or irrevocable.

Which option you choose should depend on your goals for the trust. Whether a trust is revocable or irrevocable has a major impact on trust administration and, potentially, your beneficiaries, so it is important to consider this decision carefully.

Trusts are the cornerstone of the modern estate plan. They can have many tax and financial implications. It’s not an ideal choice to DIY trust creation, so working with an experienced trust attorney is typically a good option. Find out more about irrevocable and revocable trusts below.

What Is a Trust?

A trust is really nothing more than a contract among three parties. It involves a fiduciary relationship. The word fiduciary means some level of trust and a responsibility to handle matters in keeping with the best interests of someone else.

In the trust arrangement, the parties typically include:

  • The Donor. This is the person behind a trust’s creation – the person who creates the trust and gives property or assets to the trust. The Donor, usually with the help of a qualified estate planning attorney, will decide what terms and conditions will be included in the trust agreement (the contract). The provisions of the trust agreement define how assets in the trust should be managed and when and how they should be distributed to beneficiaries. The Donor is often the person who contributes assets to the trust, though trusts can be set up to allow for third-party contributors. Some trusts will have more than one Donor. It has become common for married couples to create a Joint Trust, in which case they are both Donors of the trust. The Donor can be known by other names. The IRS prefers the term “Grantor”. Some states use the terms “Trustor” or “Trust Maker”. Regardless of which title is used, this party is responsible for trust creation.
  • The Trustee. This is the person or entity that manages the assets owned by the trust. Think of the Trustee as the equivalent of the CEO of a corporation. The Trustee is tasked with fiduciary responsibility for the trust. The Trustee must manage the trust assets, protect the assets of the trust, make appropriate decisions about investing or using those assets in keeping with the desires of the trustor and the interests of any beneficiaries, and distribute assets to beneficiaries as dictated by the provisions of the trust. The Trustee is responsible for proper trust administration.
  • The Beneficiary. This is the person or persons who benefit from the trust. The Beneficiaries get to use and enjoy whatever it is that the trust owns.

It is possible to create some trusts where the Donor, the Trustee and the Beneficiary are, at least initially, all the same person. But in order to have a valid trust, all trusts must have at least one other person involved as at least one of the other parties in the contract. Most trusts created for estate planning purposes will have at least one future interest beneficiary – someone who will be the beneficiary after the Donor has passed away. If the Donor is named as the initial Trustee, most trusts will provide a list of successor trustees who can take over if the initial Trustee becomes incapacitated or dies.

What Is an Irrevocable Trust?

The word irrevocable means that something can’t be changed or cancelled – at least not by the Donor. That’s the idea of an irrevocable trust in spirit. These types of trusts are typically designed so that once the trust is created and assets are put into it, the Donor cannot change the trust terms or have a gift returned. Today, most irrevocable trusts are written with a great deal of flexibility. While the Donor may not be allowed to amend or change the terms of a trust, it is common to give the ability to amend the trust to someone else. Additionally, the Donor may be given the right to “swap” assets with the trust, so that an asset that was given away can be returned for something of equal value. While there can be important tax consequences to including these types of provisions in an irrevocable trust, a properly written irrevocable trust can give enormous flexibility to both the Donor and the Beneficiary.

Keep in mind that a revocable trust, meaning the Donor has reserved the right to amend or cancel the trust, will become an irrevocable trust when the Donor dies. That is because after a death, the Donor can no longer amend or cancel a trust. So once the Donor has passed away, normally the trust will automatically become an irrevocable trust.
Whether or not a trust is irrevocable is determined by state law as well as the wording of the trust itself. If trust documents don’t speak to revocability at all, the IRS notes that most states consider the trust to be revocable.

As mentioned, it is often possible to amend an irrevocable trust. Typically, there are at least four methods to amend an Irrevocable trust. In most states, it is possible to file a court proceeding to amend an Irrevocable Trust. But because court proceedings can be very expensive, it is often the least desirable approach. Under the laws of some states (or if the trust terms permit), irrevocable trusts may be amended by agreement of the Donor (if available), the Trustee and all of the Beneficiaries. More sophisticated trusts may include provisions for a special kind of fiduciary called a Trust Protector. Trust Protectors are often given the ability to amend a trust. But, depending on how the trust is set up in the first place, your options may be limited. Finally, some states permit a method of changing a trust called “decanting”. With this method of changing an irrevocable trust, the assets are removed from the original irrevocable trust and transferred to a new irrevocable trust with improved terms and conditions. Decanting has many rules and restrictions and should only be done with the help of a qualified trust attorney.

Potential Pros and Cons of Irrevocable Trusts

Generally, irrevocable trusts are NOT all-purpose trusts and are not a good tool to use as a Will substitute. Each type of irrevocable trust is used for a very limited, specific purpose. Irrevocable trusts are to estate planners what a toolbox is to a carpenter. Just as a carpenter carries different tools for different woodworking tasks, an estate planner will use the various types of irrevocable trusts as a collection of legal tools tailored to specific financial needs. It’s like having a toolbox filled with saws, hammers, and measuring tools, enabling the carpenter to tackle various projects with expertise and accuracy.

Because the Donor, in his or her capacity as a Donor, doesn’t have direct control or access to the assets in an irrevocable trust—aside from what is written into the trust provisions—this form of trust can provide additional protection against creditors and taxes. This type of trust can even provide potential protection against certain types of future legal claims, such as medical malpractice lawsuits.

However, the same control limitations that can protect you in one circumstance might become a burden in another. If you experience a shakeup in your financial status and suddenly need the assets in your trust to pay for everyday expenses or bills, you may not be able to easily access them.

What Is a Revocable Trust?

The word revocable means that something can be changed or reversed. It’s the opposite of irrevocable, and in many ways, a revocable trust is the opposite of an irrevocable trust. These types of trusts are much easier to amend.

You still transfer assets into the trust and they are still managed according to the trust provisions by a trustee. If you create a trust during your lifetime with yourself as the beneficiary, you can make yourself the trustee or choose to have someone else manage the assets on your behalf, according to your direction, and for your benefit.

Potential Pros and Cons of Revocable Trusts

Revocable trusts provide a lot more control and flexibility. You don’t typically need to go through as much work to make a change to such a trust, and your options for amending a revocable trust are much wider than they are for amending an irrevocable trust. Revocable trusts are the “all-purpose” trust in an estate plan. Revocable trusts are like a Swiss Army knife. They can accomplish many goals with one document. For that reason, they are a great substitute for the traditional Will.

However, revocable trusts won’t provide asset protection to the Donor like an irrevocable trust can.

Which Type of Trust Is Right for You?

The type of trust that is right for you depends on your goals and needs. If you are looking to: (1) pass wealth at death; (2) provide for the right people to be in charge upon your incapacity; (3) avoid the probate process; (4) reduce estate and income taxes; and/or (5) provide protection from divorce, lawsuits, bankruptcy, and future estate taxes on the assets you will leave to your loved ones, then a properly drafted revocable trust might be the right fit for you.

Do you want to protect your assets against your future creditors, reduce your tax burden, or provide funds for beneficiaries that they can only use for specific purposes? Then an Irrevocable Trust might be a better choice. These are just a few common goals related to trust creation, and most people have several goals in mind.

Get Professional Help with Trust Creation and Administration

The best way to understand the type of trust or other estate planning that might be right for you is to speak with an experienced trust attorney. Your legal team can help you explore all your options and make educated decisions about protecting your assets, creating a legacy for the future, and supporting your beneficiaries. Remember that trust creation is only the first step. You want to be sure that the team you choose to help you and your family will have the experience and expertise to help you with trust administration after your trust is signed.

For more information about trusts and to get started on creating yours, reach out to the Law Offices of Boyd & Boyd, P.C., at 508-444-9688.