What’s the Difference Between a Revocable and Irrevocable Trust in Estate Planning?

What Role Do Trusts Play in Estate Planning?

A trust is a written fiduciary agreement in which a third party, called a trustee, holds assets on behalf of one or more beneficiaries. Trusts are governed under the Pennsylvania Consolidated Statutes, Title 20, Chapter 77. Trusts may be constructed in many different ways to control exactly when and how assets pass to beneficiaries. They usually avoid probate for quicker access to assets, saving time and expense and potentially reducing taxes. As probate is a matter of public records, trusts can help protect your privacy. 

Trusts allow for better control over your assets. With a revocable trust, you can retain access to your assets during your lifetime and specify who the remaining assets will pass to after your death. A strategically structured trust can help protect your estate from creditors of your heirs and even from beneficiaries who lack money management skills.

What Is the Key Difference Between Revocable and Irrevocable Trusts?

Although there are many types of trusts, the two main categories are revocable and irrevocable. The critical difference is that a revocable trust can be revoked (dissolved) at any point during the grantor’s lifetime, while an irrevocable trust cannot. Both types of trusts are important estate planning documents.

How Are Revocable Trusts Used in Estate Planning?

A revocable trust is also known as a living trust. It can help keep assets out of probate while allowing for control of those assets during the grantor’s lifetime. Upon the death of the grantor, a revocable trust usually becomes irrevocable. 

One important benefit of this type of trust is its flexibility. Life is full of changes. If your circumstances or your intentions regarding the distribution of your assets change, a revocable trust can be dissolved. With a revocable trust, you have the option to name yourself as trustee and retain control over the trust and its assets while you are living and designate a successor trustee to administer the trust in your place in case of your incapacity or death. 

However, a revocable trust is treated like any other asset and subject to income taxes, as stated by the Pennsylvania Department of Revenue. During the grantor’s lifetime, trusts are required to report and pay taxes on income received during the year. Revocable trusts are also usually subject to estate taxes. 

What Are the Characteristics of Irrevocable Trusts?

After it has been executed, an irrevocable trust cannot be altered by the grantor, and control over the assets in the trust is lost. The grantor does not have the option to dissolve the trust or change any of its terms. This type of trust may help protect assets against a legal judgment.

An irrevocable trust transfers assets out of the grantor’s estate, avoiding probate and potentially reducing estate taxes. Once assets have been transferred to the trust, the grantor is relieved of tax liability for income generated by those assets. However, distributions from an irrevocable trust are typically taxable. An irrevocable trust must be appropriately structured to reduce inheritance taxes. In a November 29, 2010, tax law ruling, the Pennsylvania Department of Revenue concluded that an irrevocable trust that expressly permits the grantor to alter the disposition of assets up until death is subject to state inheritance tax, even though the grantor has no right to trust income. 

What Types of Revocable and Irrevocable Trusts Are Used in Estate Planning?

Trusts are often used to minimize estate taxes and to provide other benefits in a strategically designed estate plan. Many different types of trusts can serve as valuable estate planning tools. Common examples include:

• Testamentary trust: Outlined in a will and created after death through the will with funds subject to probate and transfer taxes, it is usually subject to probate. 
• Irrevocable life insurance trust: These trusts are designed to exclude life insurance proceeds from the taxable estate of the deceased while providing liquidity for beneficiaries.
• Marital trust: Also known as an “A” trust, it provides benefits to a surviving spouse and generally becomes part of the surviving spouse’s taxable estate. 
• Bypass trust: Also known as a “B” trust or credit shelter trust, it is intended to bypass the estate of the surviving spouse to make use of the federal tax exemption for each spouse.
• Generation-skipping trust: Allows assets to be distributed to grandchildren, utilizing the generation-tax exemption, without incurring estate taxes or generation-skipping tax on the subsequent death of the grantor’s children.
• Charitable lead trust: Transfers specific benefits to a charity, with the remainder going to named beneficiaries.
• Charitable remainder trust: Allows for an income stream that continues for a specified time, after which the remainder goes to charity.
• Grantor Retained Annuity Trust: Irrevocable trust designed to shift appreciation of rapidly appreciating assets to the next generation during the lifetime of the grantor.
• Qualified Terminable Interest Property (QTIP) Trust: Designed to provide income for a surviving spouse, upon whose death, assets go to additional named beneficiaries and maximizes estate tax planning flexibility. 

Do You Need an Estate Planning Attorney?

Wills and trusts are complicated estate planning documents. They must be drafted with skill and comply with state and federal laws. A law firm with specialized knowledge regarding estates, trusts, and probate can provide the expertise and sound legal counsel you need for a well-crafted estate plan. At Peak Legal Group, we have the experience and legal skills to construct an estate plan tailored to your needs. Contact us at (610) 989-7064.