Definition:
A revocable trust is a trust that can be modified, amended, or revoked after it is created in general. The terms of the written trust document are fixed, with only rare exceptions.
How does a revocable trust work?
A revocable trust is a trust that cannot be changed or revoked after it is created, at least not without the consent of all beneficiaries or court approval. A revocable trust avoids the probate process, which is the legal process required to transfer ownership of assets from a deceased person to a living beneficiary.
In contrast, a revocable living trust remains in the control of the owner, as it can be modified or dissolved at any time. This means that the owner has full access to the funds until the time of their death.
A trust can hold assets and transfer them to the beneficiary weeks, months, or even years after your death. The terms of the revocable trust do not become publicly recorded, as your trust is not subject to probate. If you leave behind just a will, it must be submitted to the court to initiate the probate. Anyone can read it.
Note: When funding a revocable trust with money or assets, you automatically provide a way to transfer ownership of those assets to the beneficiaries you choose at the time you choose, making probate unnecessary.
A revocable trust protects assets in the event of a lawsuit. You cannot regain ownership after transferring it to a revocable trust, so creditors or judgment holders cannot access it either.
Examples of a revocable trust
If you create a revocable trust for a beneficiary to receive money after graduating from college, and later decide that you would prefer them to receive the money when they turn 18, you will not be able to change that plan, as the trust cannot be modified or amended.
In some cases, you may be able to make changes to a revocable trust.
Most states have legal options to allow beneficiaries to revoke a revocable trust under certain unforeseen conditions. This usually requires unanimous consent from all beneficiaries, and it may not be possible if any of them are minors. They may also petition the court to “unbundle” the trust, which involves creating a new trust with updated terms and transferring the assets of the first trust to that new trust.
Note: A court may determine that you created a revocable trust to keep assets and money out of the hands of a judgment holder if you funded it while a lawsuit was pending against you, even if an event occurred that could lead to a lawsuit. Your trust arrangement may be annulled if it can be proven that you created it in “anticipation” of an event.
You may also draft trust formation documents to give the appointed trustee the authority and flexibility to address unforeseen circumstances. For example, a grandparent may allocate funds for a grandchild’s education, but the grandchild may face a life-threatening medical condition requiring expensive treatment after the grandparent’s death. The trustee may seek to modify the trust to cover the treatment costs for the child’s benefit.
Tax treatment of funds in a revocable trust
Funds transferred to a revocable living trust do not contribute to the value of your estate for estate tax purposes.
Property valued at over $11,700,000 in 2021, or over $12,060,000 in 2022, is subject to federal estate tax on the excess over this threshold. Under the provisions of the Tax Cuts and Jobs Act (TCJA), these exemptions will remain in effect beyond 2025 for contributions made to the trust prior to that time. The exemption level is scheduled to revert to a range of $5 million (indexed for inflation) when the TCJA expires at the end of 2025.
Tax Treatment
Benefits
Assets in an irrevocable trust may be counted against you or the beneficiary for the purpose of qualifying for certain government benefits, including Supplemental Security Income. The assets in the irrevocable trust may not be “counted” as your assets by the Medicaid program, as long as you placed the assets in the trust before the “look-back period.”
Note: In most states, funding an irrevocable trust at least five years before needing assistance in nursing homes protects those assets, as you have given them to the trust and no longer have control over them.
An irrevocable trust can also protect special needs beneficiaries by allowing them to qualify for government benefits, which they may not be able to receive if they received the assets directly.
Types of Irrevocable Trusts
Irrevocable trusts come in several different forms:
Living Trust
Also called a “revocable living trust,” it is any trust created and funded by an individual during their lifetime.
Testamentary Trust
These trusts are always irrevocable, as they are not created or funded until after the death of the grantor. They are created according to the terms of the deceased’s last will.
Irrevocable Life Insurance Trust (ILIT)
This type of living trust can be set up to accept death benefits at the time of your death to avoid including the value in your estate for inheritance tax purposes.
Charitable Trust
A charitable trust pays the remainder of your assets to beneficiaries first, then distributes the balance of your assets to a charity. You can also set it up to operate as a charitable lead trust, where the charity is paid first.
Irrevocable Trust vs. Revocable Trust
Irrevocable Trust Revocable Trust
Cannot be modified, changed, or revoked Can be dissolved at any time as long as you are still competent
Not counted toward estate Considered current income, as you can revoke it at any time
Remains private No estate tax protection
You can dictate when assets are to be transferred to beneficiaries No protection from lawsuits
Tax protection Protection from lawsuits
Alternatives to Irrevocable Trusts
A revocable trust is one you can dissolve or modify at any time you want as long as you are still competent, so it does not protect from legal liability or estate taxes. You can reclaim the property you place in a revocable trust, so the law considers you to still be the owner. A revocable trust automatically becomes irrevocable upon your death since you are no longer available to change or revoke it.
Sources:
The American College of Trust and Estate Counsel. “Can I Change My Irrevocable Trust?”
Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2022.”
Internal Revenue Service. “Estate Taxes.”
Internal Revenue Service. “Estate and Gift Tax FAQs.”
Social Security Administration. “Understanding Supplemental Security Income – 2021 Edition,” Pages 84-85.
Pennsylvania. “Medical Assistance and Payment of Long Term Care Services.”
Illinois Revenue Department. “What Is an Inter Vivos Trust?”
Illinois Revenue Department. “What Is a Testamentary Trust?”
Internal Revenue Service. “Abusive Trust Tax Evasion Schemes – Special Types of Trusts.”
Internal Revenue Service. “Charitable Trusts.”
Source: https://www.thebalancemoney.com/what-is-an-irrevocable-trust-3505400
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