What is the difference between revocable versus irrevocable trusts?
An inter vivos trust – a trust set up that goes into effect while the initiator is still alive – can be either revocable, meaning the individual can change their mind, or irrevocable, meaning every element is permanent.
Irrevocable trusts are the easier of the two to understand. After placing property into an irrevocable trust, the property can’t be retrieved. For all intents and purposes, that property now belongs to the trust exclusively.
With a revocable trust, however, property can be placed into the trust and at some point in the future, the transfer may be reversed by removing the property and terminating the trust.
There will most likely be gift tax consequences when establishing an inter vivos irrevocable trust, so make sure any accountant and attorney are given proper notification. Also, certain transfers within certain time periods prior to an individual’s death can be included in the estate as “gifts in contemplation of death” under both state and federal statutes. Be aware of possible death tax implications. With a 55% Federal estate tax, Uncle Sam may be first in line to claim the property!
The most significant distinctions between revocable and irrevocable trusts are the estate tax considerations. Property placed in an irrevocable trust is no longer considered part of an individual’s estate, meaning that the property typically isn’t included in the estate’s value when it comes to determining if death taxes are owed and, if so, how much.
Property placed into a revocable trust is still owned, and therefore that property is still subject to death taxes. If an individual can change their mind about the trust and retrieve the property from the trust at any time while they are still alive, the property is really theirs and should be considered part of their estate.
So if tax breaks are only with an irrevocable trust, why would anyone want to use a revocable trust without the estate tax break? Estate tax savings is only one of the reasons one may consider including a trust in estate planning. If the estate’s value is nowhere near the federal estate tax exemption, then one really does not need to be concerned about federal estate-tax-saving tactics.
Motivation for setting up a trust may have more to do with estate protection or helping out a charity, but individuals may also want a safety valve that allows them to pull money out of a trust if circumstances change in some way.
Make sure to work with an accountant to understand any and all tax implications – gift, federal estate, and state inheritance or estate – for property transfers to both irrevocable and revocable trusts. He or she can help set up the right provisions and avoid tax-related surprises from the government because of some unknown provision of the tax code.