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Trusts are an important tool for estate planning. They broadly fall into two categories: revocable and irrevocable trusts.
But how do irrevocable and revocable trusts differ, and which is better for you? This guide helps you make an informed decision.
An irrevocable trust, while offering substantial benefits like asset protection and tax advantages, comes with a significant downside: loss of control. Once you create an irrevocable trust, you relinquish ownership and control of the assets transferred to it. This means you cannot access, manage, or sell these assets without the trustee’s permission.
Here’s a deeper dive into the downsides of an irrevocable trust:
1. Limited Control:
- No Access to Assets: You cannot directly access or use the assets in the trust. Any access requires the trustee’s approval.
- No Management Control: You cannot manage or sell the assets in the trust. The trustee has the sole authority to manage and distribute them according to the trust terms.
- No Modification: You cannot change the terms of the trust once it’s established. This includes modifying beneficiaries, distributions, or even dissolving the trust.
2. Potential Conflicts with the Trustee:
- Disagreements with Trustee: If you have a strained relationship with the trustee, disagreements about asset management or distributions can arise.
- Trustee Mismanagement: While rare, there’s a possibility of the trustee mismanaging the assets or acting against your wishes.
3. Tax Implications:
- Additional Tax Returns: You may need to file additional tax returns for the trust, depending on its complexity and income generation.
- Loss of Tax Benefits: You may lose certain tax benefits associated with owning the assets directly, such as depreciation deductions or capital gains tax benefits.
4. Estate Planning Considerations:
- Medicaid Eligibility: Assets in an irrevocable trust may disqualify you from receiving Medicaid benefits for long-term care.
- Estate Tax Implications: While the trust assets may not be part of your taxable estate, they could still be subject to estate taxes depending on the trust’s structure and beneficiaries.
5. Cost and Complexity:
- Legal Fees: Setting up an irrevocable trust typically involves higher legal fees due to its complexity and the need for specialized legal expertise.
- Administrative Costs: Ongoing administrative costs associated with managing the trust can be significant.
6. Potential for Litigation:
- Disputes Among Beneficiaries: Disputes among beneficiaries over distributions or trust management can lead to costly litigation.
- Challenges to Trust Validity: Beneficiaries or creditors may challenge the validity of the trust, leading to legal battles.
Before establishing an irrevocable trust, carefully weigh the benefits against the downsides. Consider consulting with an experienced estate planning attorney to understand the implications and ensure the trust aligns with your specific goals and circumstances.
Remember:
- Loss of control is the primary downside of an irrevocable trust.
- Carefully consider the potential conflicts with the trustee, tax implications, and estate planning considerations.
- Seek professional legal guidance to ensure the trust is structured to meet your needs and avoid potential pitfalls.
By understanding the downsides of an irrevocable trust, you can make an informed decision about whether it’s the right estate planning tool for you.
Pros and Cons of a Revocable Trust
A revocable trust has some pros and cons to consider.
Flexibility and Control Over Assets
When you set up a revocable trust, you essentially keep total control over the assets that are placed in the trust. The terms of the trust can be altered at any time. You can use or sell the assets as you wish.
This is not the case with an irrevocable trust. If you decide to use this estate planning tool, you are giving up a lot of control over your assets because it is nearly impossible to change any of the terms of the trust. Furthermore, you are not the trustee and cannot personally oversee the trust’s assets.
You have significantly greater asset protection when you use an irrevocable trust. There is more protection from creditors because you have essentially given up control over the trust assets and cannot just access them at will. Additionally, you might be able to shield irrevocable trust assets from inheritance tax.
Furthermore, if you take the right steps (like setting up a trust well in advance), the assets contained in it might not be taken into account when figuring out whether Medicaid will cover your nursing home care.
Because you still have control over the trust’s assets, you run the risk of losing them to creditors. Additionally, the trust’s assets may keep you from being eligible for Medicaid nursing home coverage, which is only available to those with low incomes.
Additionally, even though the assets in your revocable trust pass away without going through probate, they are typically still included in your taxable estate, which means estate tax may need to be paid on them.
DON’T Use an Irrevocable Trust Without These 4 Things
FAQ
Why would you want an irrevocable trust?
Can you spend money out of an irrevocable trust?
Why do lenders not like irrevocable trusts?
What are the pros and cons of an irrevocable trust?
An irrevocable trust can have its benefits but there are also some dangers to keep an eye on before deciding to move forward. Here are the most common pros and cons of an irrevocable trust: In addition to protecting assets from creditors, irrevocable trusts can also come in handy for managing estate tax obligations.
What are the tax consequences of an irrevocable trust?
There are also tax consequences of irrevocable trusts. Once a settlor transfers their property or assets to a trust, they will be relieved of tax liabilities that are associated with the asset or property. There are, however, also some cons an individual should consider when creating an irrevocable trust. One major con is inflexible terms.
Are trusts revocable or irrevocable?
Trusts can either be considered revocable or irrevocable. Revocable trusts are more common, and they can give you more control over your assets while you’re still alive. With an irrevocable trust, the government no longer sees you as the owner of your assets; the trust is the owner.
What happens if you put assets in an irrevocable trust?
Once assets are placed into an irrevocable trust, the settlor (grantor) no longer holds any ownership rights to the assets. The trust’s assets may continue to earn income like interest, rent from real estate, capital gains, or other types of income. The trust itself must pay taxes on that income.