What is the difference between a revocable trust and an irrevocable trust?
Managing Director, Head of Wealth Planning and Advice, J.P. Morgan Wealth Management
What is a trust?
A trust is a legal agreement between a person creating the trust (the grantor or settlor) and the person they select to be in charge of the trust (the trustee). The agreement benefits one or more people who are called beneficiaries. This legal agreement results in the creation of a legal entity known as a trust. There are many different types of trusts, and the purpose of this article is to discuss the two most common types of trusts: revocable trusts and irrevocable trusts.
What is a revocable trust?
When most people think of trusts that are used in the estate planning process, they are thinking of a revocable trust. Depending on where in the country you are located, a revocable trust might also be known as a living trust or a combination of these terms, such as a revocable living trust.
At its core, a revocable trust is a highly customizable legal arrangement whereby the grantor can control the mode and method of the distribution of the assets after their death. A revocable trust is created during the grantor’s lifetime and can be amended or revoked as long as the grantor is alive.
Key components of a revocable trust:
- The grantor retains the absolute right to amend, modify or revoke any and all terms of the trust. Basically, until the grantor passes away or becomes incompetent, the grantor can revise their trust (with the help of an attorney) whenever it suits them.
- One of the primary benefits of using a living trust is to avoid probate at the death of the grantor. Probate is a court supervised process to transfer assets that can be expensive and time consuming. Probate records are generally part of the public record, which means anyone can see what is in the deceased’s estate and how those assets are distributed (or not distributed) to the decedent’s beneficiaries. The administration of a revocable trust accomplishes all the same things as a probate, but in a way that is generally a far quicker, less expensive and more private than the probate process.
Protect your legacy with a trust
Explore self-directed investing and managed trust account options with J.P. Morgan Wealth Management to help you distribute your assets according to your wishes and make your estate planning easier.
- A funded revocable trust – that is, a trust the grantor has moved assets into – can also help manage the grantor’s affairs if the grantor becomes incapable of doing so. Rather than relying on a power of attorney, which in some circumstances can be difficult to use in practice, the successor trustee of a revocable trust can step in to the shoes of the grantor and continue to administer the grantor’s assets with little hassle. If any assets remain in the grantor’s name outside the trust, a power of attorney or guardianship would likely still be needed.
- All assets in the revocable trust or that go to the revocable trust at the death of the grantor are included in the grantor’s estate for federal estate tax purposes. A revocable trust does not provide income tax, estate tax or creditor protections for the grantor, but it may provide these benefits to beneficiaries after the grantor’s death. A revocable trust becomes irrevocable at the death of the grantor.
What is an irrevocable trust?
While this may sound obvious, it is still important to state that every type of trust that is not a revocable trust is an irrevocable trust. There are many different types of irrevocable trusts. Typically, an irrevocable trust is created for a specific purpose, such as holding life insurance outside of the taxable estate (an irrevocable life insurance trust), holding assets for the education of children or grandchildren (an education trust), holding assets for a disabled individual (a special or supplemental needs trust), protection from an individual’s assets (a creditor-protection or asset-protection trust) or any number of other purposes.
Key components of an irrevocable trust:
- After an irrevocable trust is created, its terms cannot be changed. This does not mean, however, that an in irrevocable trust cannot be drafted in a way that allows the trust to be flexible and able to adapt to changing circumstances. Grantor, typically, has no rights to revoke the trust and the ability to amend the trust is extremely limited.
- Irrevocable trusts may be grantor trusts or non-grantor trusts. With grantor trusts, the grantor pays all the tax on any income and gain generated by the trust’s investments, while with non-grantor trusts, the trust has its own tax identification number and the trust files its own tax return. Some trusts can start as grantor trusts and become non-grantor trusts after a certain amount of time or a specific event.
- An irrevocable trust may be drafted so that its assets are included in the taxable estate of the grantor or excluded from the taxable estate of the grantor. The same can be true for beneficiaries: an irrevocable trust may be included or excluded from the taxable estate of the beneficiary. If you want to exclude the assets in an irrevocable trust from a beneficiary’s estate you should have an estate planning attorney and an accountant who have experience dealing with the issues involved in generation-skipping transfers.
- The only true constant when comparing different irrevocable trusts is that each one is created for a unique purpose and the terms contained within are unique. No two irrevocable trusts are identical and an attorney is needed to create and review an irrevocable trust to determine what rule apply to it.
The bottom line
Revocable trusts are arguably the most flexible and popular type of estate planning vehicle available in the United States and are an important foundation of a good estate plan. Irrevocable trusts are common in more complex estate plans and each irrevocable trust is uniquely designed to fulfil its specific purpose. A revocable trust and an irrevocable trust serve very different purposes and do not replace one another; often your plans can incorporate both a revocable trust and an irrevocable trust to accomplish your goals. You should consult with your own legal counsel to understand whether a revocable or an irrevocable trust might be beneficial for you.
Invest your way
Not working with us yet? Find a J.P. Morgan Advisor or explore ways to invest online.
Managing Director, Head of Wealth Planning and Advice, J.P. Morgan Wealth Management
