What is the difference between a revocable and an irrevocable trust?

Revocable trusts

A revocable trust — usually a revocable living trust — is mainly a tool for avoiding probate and planning for incapacity. The creator (grantor) typically serves as trustee, controls the assets completely, and can amend or revoke the trust whenever they want. Because of that control:

• Income is taxed to the grantor on their own return; no separate tax return is usually needed.
• The assets are included in the grantor's estate for estate tax purposes.
• The grantor's creditors can reach the assets.
• The assets count as the grantor's for Medicaid eligibility.

When the grantor dies, a revocable trust becomes irrevocable and the successor trustee administers it according to its terms.

Irrevocable trusts

In an irrevocable trust, the grantor transfers assets and gives up the right to take them back or change the terms, except in limited ways. Someone else usually serves as trustee. Because the grantor no longer owns the assets:

• The assets are generally removed from the grantor's taxable estate.
• They can be protected from the grantor's future creditors, if the transfer was not fraudulent.
• After a five-year lookback, they may not count for Medicaid long-term care eligibility.
• The trust may have to file its own tax return, and trust income can be taxed at compressed trust brackets — unless it is designed as a “grantor trust” for income tax.

Common kinds of irrevocable trusts

• Irrevocable life insurance trust (ILIT) — owns a life insurance policy so the proceeds are not taxed in the insured's estate.
• Medicaid asset protection trust — holds a home or savings so they are not counted if long-term care is needed more than five years later.
• Special needs trust — provides for a person with a disability without disqualifying them from SSI or Medicaid.
• Charitable remainder and charitable lead trusts — combine gifts to charity with income or tax benefits.
• Spousal lifetime access trust (SLAT) and grantor retained annuity trust (GRAT) — used by wealthier families to move growth out of the taxable estate.
• Domestic asset protection trust — allowed in about 20 states, such as Nevada and Delaware, and designed to shield assets from future creditors.

Is “irrevocable” really permanent?

Not always. Many states allow irrevocable trusts to be modified with the consent of all beneficiaries, through court petitions when circumstances change, or through “decanting” — pouring the assets into a new trust with updated terms. Trust documents can also appoint a trust protector with power to make certain changes. These options are limited and must be used carefully to preserve tax and Medicaid benefits.

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Choosing between them

• Choose a revocable trust if your goals are avoiding probate, privacy, incapacity planning and flexibility.
• Consider an irrevocable trust if you have a specific goal that requires giving up control: reducing estate tax on a large estate, protecting assets from future long-term care costs or creditors, providing for a disabled family member, or making major charitable gifts.

Many families have both: a revocable living trust as the core of the plan and one or more irrevocable trusts for particular purposes.

Taxes at a glance

Transfers to an irrevocable trust are usually taxable gifts, reported on a gift tax return, although most people owe no gift tax because of the large lifetime exemption. Assets given away during life generally keep the donor's tax basis instead of getting a stepped-up basis at death, which can mean higher capital gains tax for heirs. That trade-off is a key part of deciding whether an irrevocable trust makes sense.

Getting advice

Irrevocable trusts are hard to undo, so they should be drafted by an experienced estate planning or elder law attorney, often with input from a tax adviser. Ask the lawyer to explain what control you give up, who the trustee will be, and how the trust will be taxed.

Who should be the trustee?

For a revocable trust, the grantor usually serves and names a family member or professional as successor. For an irrevocable trust, the trustee is usually someone other than the grantor — a family member, friend, bank or trust company — because too much control by the grantor can undo the tax or Medicaid benefits.