There are a lot of different ways to describe a trust. One of the basic defining characteristics is whether the trust is revocable or irrevocable. So, what are the differences?
In the case of a revocable trust, you can make changes a much as you want. You can add assets or take them out whenever you want. You can completely defund the trust and shut it down. You can change the language of the trust (like changing a beneficiary).
On the other hand, irrevocable trusts are very hard to change. Generally speaking, once the assets are in the trust, they’re pretty much in there for good. It’s pretty hard to change the trust language as well. It is worth noting though, that you might be able to get assets out of an irrevocable trust through a process called decanting. But it isn’t guaranteed.
Revocable trusts (called a grantor trust by the tax code) do not affect your income taxes at all. Since you control the assets inside the trust, any income generated by the trust flows to your tax return. Revocable trusts also have no effect on any estate taxes, for the same reason…you control the assets.
The same is not true with irrevocable trust. In an irrevocable trust, it depends on what happens with the income. If the trust pays out the income to beneficiaries, then the beneficiaries pay the income tax. If the trust retains the income, then the trust pays the income tax. The trust document will normally state what is to be done with the income. Irrevocable trusts do affect your estate taxes. Assets inside an irrevocable trust are no longer yours, so they’re not part of your taxable estate. This is one of the prime reasons to consider an irrevocable trust.
Assets inside a revocable trust are not protected, if you get sued. If properly structured, an irrevocable trust can protect your assets, if you get sued. One of the key points is the assets must be in the trust before you think you might get sued.
Qualifying for Government Programs
An irrevocable trust can be used to help you qualify for Medicare or certain needs-based Veterans benefits, if you chose to use them for such. But there are look-back periods and if you don’t qualify for the assistance, you can’t get the funds back. Revocable trusts do not help you qualify for these programs.
Life is Complicated
Your financial life can be pretty complicated. Working with someone who deals with finances every day can be a good idea. If you’re active or retired military, we think your benefits add another level of complexity. We also think that if you’re going to work with a financial advisor, you should work with one that deals with your special circumstances every day. If you’d like to chat, give us a call.
If you found this article useful, you might like the following blog posts: