Revocable vs Irrevocable Trusts: Which is the Right Choice for You?

[00:03:25] So today’s topic we’re going to discuss the type of trust,[00:00:00] Atty. James Jones: Welcome to Legacy Talk. I’m your host, James Jones. I’m an estate planning and probate attorney in Tacoma, Washington. I’ve been practicing for over 20 years, and my main practice areas include estate planning, probate, and estate administration. On Legacy Talk, we discuss topics surrounding families and estates.

[00:00:17] Estate planning is often a confusing and complicated topic, but my goal with this podcast is to make it accessible and understandable to those who need it. So if this is something that interests you, I’d appreciate it if you click the subscribe button and like this episode so that you can follow along as we break down the barriers to estate planning.

[00:00:37] I’m excited to get to today’s topic as always. As you probably know, I’m always excited to get to the today’s topic. Today’s topic is Revocable Versus Irrevocable Trust. Which Is The Right Choice For You? Because this is one of the most common questions that I get in my office and a misunderstood part of estate planning that I thought we needed to talk about.

[00:00:59] So on today’s show, [00:01:00] we’re talking about Revocable Versus Irrevocable Trusts, Which Is The Right Choice For You? So let’s get to it. So every week, as you know, I record a podcast. Usually I have a few weeks of recordings in the can, as they say, in the business.

[00:01:16] And so, there’s a few weeks between recording and release because they get produced and they get cleaned up and the inconsistencies get taken out when I say too many ands and ums and ohs.

[00:01:26] And so hopefully those don’t get taken out. We’ll see. Anyway, I’m not always exactly sure what I’m going to talk about even up until the time or the day and hours before I record. And that’s how it was today before my recording session and I basically, I have every Friday, we have a staff meeting to sort of go through the week, talk about our wins, talk about things we were working on.

[00:01:52] And so I asked my staff, well, what’s a good topic for today’s podcast? I often ask that question, but today, [00:02:00] I immediately got the response. You got to talk about revocable trust versus irrevocable trust, because that’s been coming up a lot, it comes up a lot in my office. Which trust should I use irrevocable or revocable?

[00:02:13] And I’m not sure where people are seeing this, I don’t do a lot of Google research on the type of trust I should use, probably because I’m in the business. And I guess I’ve got articles and things like that on my own website to talk about irrevocable versus revocable trust, but I never really searched for it.

[00:02:28] So I’m not really sure the sources that they’re getting this, and maybe it’s some of the stuff that I put out there. But this week we had multiple clients talking about this topic. And wondering what the differences are and which one should I use in this situation or that. And so, what I normally tell people, usually a good estate plan has both irrevocable and revocable elements to it.

[00:02:49] So typically there’s a revocable trust, there’s probably some irrevocable trusts, and that really makes the best kind of an estate plan. There’s specialized irrevocable trusts and there’s specialized revocable trusts. [00:03:00] And so, over the course of this podcast, this is the 23rd episode, believe it or not.

[00:03:06] We’ve talked about irrevocable trusts that can hold beneficiaries inheritances, two weeks ago, I think an episode came out about special needs trusts, which are irrevocable trusts. And we also always, almost always, the topic of revocable trusts and their benefits comes up, so why not talk about the differences?

 irrevocable versus revocable and which one is right for you?

[00:03:35] So before I get into that, though, I need to preface this because there are differences. Revocable means It can be revoked, right? That’s the simplest definition of revocable, it can be revoked. That means it can be changed, it can be amended, it basically means that the person setting it up has full control of the trust, right?

[00:03:56] The revocable trust as we’ve often talked about, there’s three parties to [00:04:00] every trust, a grantor settlor who sets it up, grantor is what I call it.

[00:04:05] There’s a trustee, that’s number two. The manages the trust. And then there’s a beneficiary or beneficiaries that benefit from the trust with a revocable trust, like a typical revocable living trust that we typically talk about. And it’s probably the most common trust that is done. The person setting it up is all three of those people, right? They’re the grantor, they’re the trustee, they’re the beneficiary. So that’s one thing, right?

[00:04:32] An irrevocable trust. Is one that can’t be changed, typically, it’s not easy to change. It’s irrevocable, cannot be revoked without a lot of hoops to jump through. Okay. And so that’s the basic, simple definition of those things.

[00:04:48] But the difference really is there are revocable trusts and there are irrevocable trusts. But being revocable and being irrevocable is not necessarily the type of trust they are. One of the qualities that they [00:05:00] have or one of the elements that they have is that they’re irrevocable or revocable.

[00:05:05] But what the trust does really hasn’t got a ton to do with that moniker, revocable versus irrevocable. There’s many types of different trusts, there’s probably more types of irrevocable trusts than revocable trusts that I come across. But there’s different kinds of revocable trust for one reason or another. And there’s different kinds of irrevocable trust for one reason or another.

[00:05:25] So today’s episode is not to go through the hundreds of different types of trusts, you know, and their purposes and whether they’re irrevocable or revocable. But what we’re talking about is things to consider when you’re selecting what kind of trust you want to set up.

[00:05:43] Okay. Whether it’s a revocable trust, which you can change or an irrevocable trust, which typically cannot be changed. And so, if we went through all those in one episode, it wouldn’t be possible, this will be like 24 hours long and we all go nuts. So, that could be a series of episodes, maybe Sunday, like this kind of [00:06:00] irrevocable trust. Maybe we’ll do that down the road.

[00:06:01] But today’s episode is basically about 10 things to consider when deciding between a revocable trust and an irrevocable trust for your estate plan. Okay. So that’s how we’re going to do it. That’s the sort of opening statement. So you know where I’m coming from on these things.

[00:06:18] We’re not going to get into the weeds on the types of irrevocable trust necessarily. We might talk about a couple of different ones. We’re probably only going to talk about one kind of revocable trust. Which we’ve already talked about, the revocable living trust. Because that’s the one that most people do, and that’s the one that most people need.

[00:06:31] So, here’s our list, okay, of things to consider when selecting revocable versus irrevocable trust.

[00:06:40] The first thing to consider, and this always comes up, and this is one of the biggest misconceptions about the revocable versus irrevocable trust is control over assets. A revocable trust allows you to retain control of the assets within the trust.

[00:06:55] You can alter, amend, revoke the trust anytime during your lifetime, as [00:07:00] long as you have legal capacity. Your brain still works in simple terms, I guess we should say. So the reason why is because you’re all the parts, right? You’re the grantor, you’re the trustee, you’re the beneficiary that we’ve talked about.

[00:07:13] So revocable trust, you have full control over your assets. So that must mean an irrevocable trust you don’t have full control, right? So an irrevocable trust requires you to relinquish control of the assets once they’re placed in the trust. Changes and revocations are generally not allowed without everybody that’s related to the trust agreeing. Right?

[00:07:35] So that could be beneficiaries, trustees, getting on board and coming together to say, Oh, well, we can change this part of the trust, but it’s not easy, right? It’s not like a slam dunk that you walk in and you do it yourself without talking to anybody. You have to get a bunch of people on board usually.

[00:07:51] And so with an irrevocable trust, you lose control because you can’t be the trustee of an irrevocable trust [00:08:00] and have it do what you want it to do. Right? Which is primarily asset protection, which we’re getting into next or in a couple points here.

[00:08:09] Number two is a state tax implications. Okay. A revocable trust does not provide in itself a state tax benefits. The assets in the revocable trust are considered part of your estate for tax purposes.

[00:08:24] So anything that’s in this revocable trust and we’re using a revocable living trust as our basic type of revocable trust. There can be other kinds of revocable trust, but for this purpose, when we say revocable trust, we’re talking about a revocable living trust that you control completely. Okay?

[00:08:41] So those assets in that revocable trust are yours, the IRS and the department of revenue and those taxing authorities that implement the state taxes, consider those your assets, regardless of whether they’re in the trust. Okay.

[00:08:55] With an irrevocable trust, they can provide tax [00:09:00] benefits because you’re basically removing the assets from your name, which means they’re removed from your taxable estate and putting them in a trust that you don’t control, right?

[00:09:11] And so, that has the potential to reduce your estate taxes. And if you’re a married couple and you want to take advantage of your exemption, we haven’t talked a lot about tax planning and that’s got to be talked about. We got to do one of those episodes, I’ve got it on my list, but if it’s a married couple, oftentimes if you have a taxable estate, that revocable trust that you set up will create an irrevocable trust to shelter the deceased spouse’s estate tax exemption amount of the estate. Okay?

[00:09:42] So that’s one reason you have both trusts in that plan, you’ve got a revocable, but it also has a irrevocable element, so that’s the state taxes.

[00:09:49] Number three, and this is the biggest reason why people think about your irrevocable versus revocable is asset protection, okay? A revocable trust [00:10:00] Offers limited asset protection from creditors during your lifetime Because the assets why?

[00:10:06] We just said it right the assets are still considered yours, even though they’re titled in the name of the trust because you’re the beneficiary, you’re the grantor, you’re usually the trustee. So they’re your assets, okay? And so even if it’s in a trust, which is basically you on paper, the revocable trust is basically you on paper.

[00:10:26] It is not an asset protection trust, those assets are open to creditors, right? They’re open as part of your taxable estate. So there’s very little estate or an asset protection planning that is part of a revocable trust.

[00:10:40] On the other hand, though, an irrevocable trust can provide asset protection. And the reason why is because the assets are legally removed from your name, and they’re put into a separate entity, which is this irrevocable trust, right?

[00:10:57] This irrevocable trust is a separate legal [00:11:00] entity. And so, if they’re not your assets, then your creditors are not going to be able to get them. Right? So that provides a level of protection, right? So if you take your assets and say, well, I’m going to put them in this irrevocable trust that is not for my benefit and I’m not in control of it to hold those assets, then those creditors are going to be out of luck, right?

[00:11:21] In general. Okay? There’s some things you can do, there’s some things they can do. If you do it while they’re trying to get after you, like there’s fraudulent conveyances and stuff like that. And so we won’t get into that, but generally, if these assets, if there’s nobody after you, creditor wise, and you put assets in an irrevocable trust, they’re going to be protected typically, okay?

[00:11:38] So number four government benefits eligibility, okay? So we talked a couple episodes ago about a special needs trust, that’s an irrevocable trust, okay? So they can help for things like Medicaid planning, social security disability planning because the assets in the trust are transferred to a trust that you do not control, that you’re not the beneficiary of [00:12:00] unless in a situation where it’s a third party special needs trust that was set up for you by your parents or a friend or brother or whatever that’s a that’s going to be an irrevocable trust that won’t count against you, okay?

[00:12:11] Oftentimes they’re subject to look back periods if you put money in an irrevocable trust for things like medicaid planning, there’s typically look back periods where it’s your five years typically where they consider that gift is like it’s not out of your name for Medicaid purposes for that five year window and so you got to plan a little bit early so there’s other eligibility requirements as well there.

[00:12:33] So an irrevocable trust can help with government benefits eligibility whereas because the assets in a revocable trust are considered your assets it doesn’t help Okay?

[00:12:44] And so you’re not going to get on Medicaid with a revocable trust, you know, you’re not going to, it’s basically you on paper, it’s your stuff, even if it’s in a trust, the Medicaid powers that be will not let you qualify if you have money like that. Okay?

[00:12:59] So [00:13:00] irrevocable trust is much better for things like qualifying for government benefits like Medicaid or social security disability or something like that. And go back, if you’re thinking about that, like special needs trust, go back to my episode on special needs trust. It talks a lot about that in that episode.

[00:13:17] Number five is privacy. A revocable trust is more private than a will, right? And the reason why is it helps avoid probate, so the distribution of your estate and your assets and things like that are not public record through the court. Okay? When you die.

[00:13:32] An irrevocable trust also avoids probate. And it also provides privacy with regard to the distribution of assets. And so, it’s basically the same, it’s basically a wash there. I don’t think there’s that big of a difference between the irrevocable and revocable as far as privacy goes, there’s things you can do to make things private and a trust by using fictitious names and things like that, just to make it so that people aren’t going to be [00:14:00] nosy and looking at your stuff, but both are pretty private.

[00:14:03] So both are pretty good for privacy if that’s what you’re looking for. They’re both pretty good for privacy.

[00:14:08] Number six is flexibility. You’re going to be flexible, more flexible with which one, right? Which one’s going to be more flexible. It’s the revocable trust, it’s highly flexible. It allows you to make changes to your financial situation and your goals as they evolve, right? Over time, maybe you have another kid, maybe you don’t want to have a kid that has money anymore that you want to cut out, you can do that.

[00:14:34] Irrevocable trusts are very inflexible typically once they’re established and that could change like your ability to make changes, right? It definitely limits your ability to make changes and you’re not going to be making any differences as far as like, I’m going to take that kid out if that kid’s already in there, right?

[00:14:54] Cause he’s not going to agree to be taken out of a trust, right? There’s ways around that, [00:15:00] right? But if you already put assets in a near vocal trust, it’s difficult to change that trust if everybody’s not on the same page. So flexibility is down low on that trust.

[00:15:08] Number seven, funding and administration costs. This is a wash, either way, both trusts have initial setup fees, right? Both trusts cost money to set up, both trusts have a little bit of legwork to get assets moved into the trust. And there’s sometimes ongoing administrative expenses.

[00:15:26] If you’re your own trustee or if you have family members that are trustee, that’s not a big thing really. And the other administrative side or funding side that might be higher is an irrevocable trust because typically, and we’re going to talk about this in the next point, you’re going to have more people helping you to deal with it.

[00:15:42] Like CPA’s, accountants, you know, financial advisors, potentially you’re going to probably have that for both and you should have that for both and you should have a financial advisor, and if you don’t and are wondering why you should have one, go back and listen to episode 21 or 20 that I had my friend Melissa Cornier on, we talked about the benefits [00:16:00] of a financial planner. So we’re getting all the links today, right? We’re getting them all today.

[00:16:05] Number eight is income tax considerations. So a revocable trust is generally not a taxable entity. Okay? It’s what by the IRS standards is called a grantor trust. And so, because the assets of this revocable trust are considered your assets, the money or income that they generate is considered your money.

[00:16:30] And so, there’s no issue as far as taxes go, it doesn’t change how you pay your taxes, it doesn’t change like you’re not going to have to do a different tax return because you have a revocable trust.

[00:16:42] With an irrevocable trust is different though, because the irrevocable trust can be and oftentimes is a taxable entity. And so, because it’s separate from the grantor, and so you’re going to often have an accountant that’ll help you, because not everybody wants to do a tax return for a trust, not everybody’s done that before. They’re not that [00:17:00] hard to do, honestly, but usually you want to get a CPA to help you with that.

[00:17:03] You can make, okay, there’s a little caveat to this income tax thing too. There are ways that you can make an irrevocable trust a grantor trust for tax purposes. And this is a pretty common thing to do in estate planning just because it’s so much easier to deal with when the grantor is the taxpayer so that the trust doesn’t have to file a tax return.

[00:17:23] And a lot of the main reason or like one of the traditional reasons why an irrevocable trust might be considered a grantor trust is so that when you make gifts to this trust, say for your kids or grandkids, the money, you’re basically maximizing the gift if the grantor you as the giftor and the grantor of that irrevocable trust continue to pay the tax.

[00:17:44] So say you gift them a hundred thousand bucks worth of stock, right? And if it’s a grantor trust, the grantor pays the tax on the dividend. Whereas if it’s a non-grant or trust, and the irrevocable trust pays its own taxes, [00:18:00] then the irrevocable trust is going to be paying the tax on the dividends and potentially reducing the principal as well in the trust.

[00:18:08] So it maximizes the gift, that’s something else that we’re not really talking about today. But you can make an irrevocable trust a grant or a trust, but for our simple purposes, revocable trusts are easier to deal with tax wise than an irrevocable trust.

[00:18:25] This is kind of a weird one, number nine. I’ve never ever met with anybody, this just came up, I don’t know. Financial aid for education. Typically people aren’t asset protection planning to provide for their kids college. Maybe that’s going to come up because college is so expensive these days. It’s ridiculously expensive these days to go to college and any of you that have kids in college or recently went to college know that it’s expensive to go to college these days.

[00:18:52] Thank you guaranteed federal loans, but I digress, the revocable trust, the assets are yours. So you’re, they’re going to count against your kid on their FAFSA. [00:19:00] So if you have too much money, that kid’s not going to get much aid. Okay? And irrevocable trust if you put it in there, it might help shield those assets from being counted for financial aid.

[00:19:12] This doesn’t come up very often, so we’ll just move to the next one.

[00:19:16] The next thing is probably the second biggest thing, maybe the first, okay? There’s asset protection, if we’re calling it asset protection, being the first thing that can cover this too.

[00:19:25] Number 10, and finally, long term care considerations. So, a revocable trust does not protect your assets from long term care qualification, okay? So we talked a minute ago about qualification for government benefits. The better trust is the irrevocable trust, because an irrevocable trust can be structured to help protect assets from being includable in your estate for purposes of things like qualifying for Medicaid or veterans benefits.

[00:19:56] Some veterans benefits require assets, you have a certain amount of [00:20:00] assets. And so, if you create an irrevocable trust, if you’re on the precipice of needing long term care, it can be a very good thing. Despite the fact that there’s often look back periods, it’s currently five years, you can have money and sort of hold it for a rainy day.

[00:20:13] And if you don’t need to spend it all, then you can basically save that money and not have spend it down to zero basically. And so you give your estate more flexibility, you give your kids more flexibility. They don’t have to cover the things that aren’t covered, which are a lot of things that are not covered under Medicaid, like personal care items and clothing and all the things, right? That you’d sort of like normal stuff that people need are not usually covered on Medicaid.

[00:20:37] And so there’s money, you need a little bit of money to cover that stuff. And so having some money in an irrevocable trust for Medicaid purposes can be really helpful. And so they are good for that, it has to be timed right and it has to be set up correctly, but they can be good for that, whereas a revocable trust doesn’t help.

[00:20:53] So now we talked about the 10 things to consider. Now it’s story time. [00:21:00] So for this week’s story, it’s pretty general. I get two types of clients primarily that ask about these questions, do I want to use a revocable or an irrevocable trust? Okay.?

[00:21:10] And so the first type of client is like, these are general. Okay? A young entrepreneur, a real estate investor, typically they want to make their assets bulletproof, right? From creditors.

[00:21:22] The second is like a middle aged couple, and they’re worried about long term care in the future, and they’re worried about losing everything if they have to go into a nursing home or long term care facility of some kind.

[00:21:34] Both of these clients want asset protection, right? The young entrepreneur, real estate person, wants to have asset protection so their real estate empire doesn’t get taken by creditors. The middle aged couple wants to shelter their assets so that they can qualify for Medicaid down the road if they need to.

[00:21:51] The problem is that neither of these clients usually thinks of the way that these irrevocable trusts, which is [00:22:00] what they would use for asset protection as we’ve talked about, have to give up control basically of these assets. So if these people, and they often don’t because they have younger kids or no kids or, you know.

[00:22:10] If they don’t have trusted children or family members or friends, it’s not really possible to have an irrevocable trust that’s sort of a wink, you know, to your kid or friend or brother or whatever, your sister, to help you hold those assets just in case you needed them later. Right?

[00:22:28] And irrevocable trust requires a separate trustee and if you set it up, you can’t be the beneficiary either, or it doesn’t give you any asset protection value. And so, if you can’t find someone to help you control the trust that you trust explicitly, like, you’re not going to be, it’s not going to work, right? You’re not going to put some random in charge of all your assets. Just for a potential creditor protection benefit not typically, at least.

[00:22:55] And so, usually for those kinds of people, there’s less [00:23:00] burdensome and less restrictive means to get asset protection through use of like business entities and things like that.

[00:23:05] And so, and create flexibility really is what you want to have. If you’re a middle aged person, think about long term care. What you really want is flexibility so that if something does happen to you, and even if you are incapacitated, someone can make decisions for you, create trusts, things like that, transfer assets. That’s usually under durable power of attorney, it can be done under a revocable trust that they set up.

[00:23:31] So really you want to put the steps in place and the flexibility in place that you can pivot if necessary. And for like a asset protection strategy for like an entrepreneur, real estate investor, there’s business entities that are very good at keeping assets protected. There’s ways to become more private, you know, things like that.

[00:23:48] So, an irrevocable trust is not the silver bullet. Always it can be very protective and very effective with regard to asset protection, Medicaid qualification, things like that. But it’s not always the perfect thing in [00:24:00] the moment. Okay? So there’s times and places as with everything and everybody’s plans different.

[00:24:05] So some people maybe it is perfectly good to give all their assets to their kids when they’re 50. I wouldn’t do it, you know, I’m 49, I’m not quite 50. So maybe I will when I’m 50, I don’t know, I’m not going to.

[00:24:16] But you know what? I mean, everybody’s situation is different. And so, most people aren’t turning away all their assets when they’re in their maximum earning years and saving years and growth years, right?

[00:24:27] So anyway, so it’s not a silver bullet, but it is something to consider, right? So most people that I ended up meeting with do revocable trusts because they’re in that middle aged pre retirement stage, not ready for like long term care, but because they have a full estate plan, they have flexibility, that if they had to pivot into like a long term care situation, even if they lost capacity through dementia or something like that, they would be able to pivot and craft an estate plan or you know, revise their estate plan [00:25:00] to become Medicaid friendly. Okay?

[00:25:03] And so, that’s it, that’s what I wanted to say today about our irrevocable versus revocable trust, hopefully it was helpful for you.

[00:25:09] Thanks for listening to today’s episode of Legacy Talk. If you liked today’s episode and would like to learn more, please like and subscribe for more great content.

[00:25:19] I’ve been your host James Jones. To your legacy.