You’ve spent decades building wealth. The last thing you want is for the government, a creditor, or a drawn-out court process to swallow a chunk of it after you’re gone.
That’s where trusts come in.
A trust lets you control exactly where your assets go—and in some cases, shields them from taxes and lawsuits entirely. But there’s a catch: not all trusts work the same way. The two main types (revocable and irrevocable) force you to make a fundamental choice between flexibility now and protection later.
Let me explain what revocable trusts and irrevocable trusts have to offer, and how you can decide which one is right for you.
What Is a Trust?
Trusts are fiduciary relationships, supported by legal documents, that allow people to protect their assets. They’re also something of a relationship, with multiple people involved:
- Grantor / Trustor: The person who establishes and funds the trust.
- Trustee: The person who manages the trust and ensures beneficiaries receive assets.
- Beneficiary: Anyone who benefits from the trust. (A trust may have multiple beneficiaries.)
A trust can simplify the process of distributing your property after you pass away and ensure your wealth goes to whoever you want it to. In that way, it’s similar to a will.
However, unlike a will, a trust can bypass the complicated and potentially expensive probate process (the court process to finalize your financial and legal matters after death). It can also be used to manage assets during your lifetime. And trusts, unlike wills, can also help you shield some of your assets from tax obligations.
Trusts have two basic structures: revocable trusts and irrevocable trusts. Both have distinct features that would-be grantors should know before establishing a trust.
What Is a Revocable Trust?
A revocable trust (aka living trust or revocable living trust) allows the grantor to make changes to the trust at any time, including adding or removing beneficiaries, changing how trust assets are managed and/or distributed, and even ending the trust.
Let’s say you married once, designated your spouse as a beneficiary, then divorced. If you remarried, you likely would want to add your spouse as a beneficiary. Revocable trusts allow for that kind of flexibility.
Revocable trusts are generally simpler than irrevocable trusts, so they’re less expensive to establish. Beneficiaries usually won’t owe taxes on principal distributions, either.
But they do have a couple of downsides. For one, assets in a revocable trust are considered personal assets, which means they’re not shielded from creditors. If you have debt when you die, creditors can use the trust’s assets to pay off those debts.
Also, revocable trusts are by definition considered grantor trusts for income tax purposes, so income taxes on interest, dividends, and/or capital gains within the trust are taxed to the grantor. And while principal distributions are tax-free, beneficiaries are generally levied on distributions of dividend income, bond interest, and rental income.
Lastly, revocable trusts become irrevocable trusts at the grantor’s death, or in the case they become permanently incapacitated and can’t manage their financial affairs.
Related: Dynasty Trusts: A Beginner’s Guide to Passing Down Wealth
What Is an Irrevocable Trust?
Irrevocable trusts, as the name suggests, can’t be changed nor ended—mostly.
Technically speaking, there are a few rare circumstances in which an irrevocable trust can be changed, and that requires both unanimous consent from all beneficiaries and court approval.
But past that, you’re not making amendments. You’re not adding nor removing beneficiaries. You’re not shutting it down. If your financial situation worsens, you can’t withdraw the assets for yourself.
Why bother? Because irrevocable trusts provide a bevy of benefits.
The most important of these, for many, is their ability to shield assets from taxes. Assets placed in your irrevocable trust aren’t considered your personal property anymore, so they—and any future appreciation on them—are removed from your taxable estate, potentially saving you thousands if not millions of dollars in estate taxes when you pass away.
You can also use your lifetime federal gift tax exclusion (currently $15 million per person) when transferring assets to the trust.
Also, unlike revocable trusts, irrevocable trusts can protect your assets from lawsuits and creditors. If you file for bankruptcy or defaulted on your debts, assets in an irrevocable trust can’t be considered for bankruptcy or court proceedings.
You should also know that irrevocable trusts can be grantor trusts or non-grantor trusts. The former pays taxes on gains and income generated within the trust, while the latter is its own tax entity—it files returns and even has its own tax identification numbers.
Because they’re more complex, irrevocable trusts tend to involve a more complicated and expensive setup process than revocable trusts.
Related: 10 Common Myths About Taxes in Retirement
Which Type of Trust Is Better?
Revocable and irrevocable trusts have their places and purposes. The one you should choose depends entirely on your specific situation.
If you want a highly customizable trust and the power to make amendments, a revocable trust is likely the better fit for you. Until you become incompetent or die, you can revise or revoke this trust. Revocable trusts are generally simpler to set up, too.
However, while irrevocable trusts make it extremely difficult to make changes, they’re not entirely inflexible. Their rules can be written in a way that they’re at least internally able to adapt based on changing circumstances. And technically, it is possible to change them—again, it’s just limited to a few situations and requires both court approval and consent of all named beneficiaries.
As previously mentioned, assets in irrevocable trusts are shielded from creditors and lawsuits, which is not the case for revocable trusts. If this is a concern of yours, an irrevocable trust may make more sense.
Before establishing a trust, thoroughly discuss your options with an estate attorney and/or financial advisor.
Related: What to Do With Your Assets If You Don’t Have Heirs
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