Passing on Wealth: Understanding the Differences Between Irrevocable and Revocable Trusts
investing-my-money | Read Time: 3 minutes
By David Stork | Published: September 2023
One might see references to a trust in publications or on television. This begs the question “What is a trust?” Merriam-Webster defines a trust as “property interest held by one person for the benefit of another.”[i] That definition just scratches the surface. A trust will have three parties to it:
- The grantor or settlor who creates the trust.
- The beneficiary of the trust. The person or organization who benefits from the trust.
- The trustee. The trustee is the person or organization that manages the assets of the trust.[ii]
Trusts can be revocable or irrevocable. A revocable trust lets the living settlor (or creator) of the trust change their mind and withdraw assets, modify the trust, or cancel the trust while an irrevocable trust cannot be modified.[iii] Below is a comparison of revocable trusts versus irrevocable trusts on a few key points.
Control: One key difference between the two types of trusts comes down to who controls the property or assets held by the trust. In the case of a revocable trust, since the settlor can terminate the trust, it is the settlor that controls the assets.[iv] In the case of an irrevocable trust, the trust itself controls the assets via the trustee (see below). [v]
Protections: Another key difference between the two rests with the protection from creditors each affords. In the case of a revocable trust, since the settlor can revoke the trust there is no asset protection. However, assets held in a revocable trust can avoid the probate process for the beneficiaries of the trust. Probate is a formal legal process for the recognition of a deceased will and the appointment of executors.[vi] Probate can be expensive depending on the circumstances. This avoidance of probate is true for the beneficiaries of an irrevocable trust as well.
With an irrevocable trust, since the settlor no longer has control, the assets may be protected from the creditors of the settlor as long as the creditor claim did not exist prior to the transfer to the trust. In addition, the assets of the trust are protected from the creditors of the beneficiary of the trust.
Beneficiaries: With a revocable trust it is typical that the beneficiary is the settlor of the trust during their lifetime. The revocable trust would have terms that explain what happens to the assets held in the trust after the settlor passes away. In this way, it can complement settlors’ or beneficiaries’ wills since, as explained above, assets held in a revocable trust would escape probate.
In the context of an irrevocable trust, the beneficiary is typically not the settlor but other individuals (often family members) or charities whom the settlor wishes to benefit.
Trustee: In the context of revocable trusts, the settlor of the trust is often also the trustee. Since the revocable trust is controlled by the settlor it is common that the trustee and the settlor are the same.
Implications for Estate/Gift Tax: The implications of revocable and irrevocable trusts for estate tax purposes are very different. Since the control of the assets rests with the settlor in a revocable trust the assets of the revocable are includable in the taxable estate of the settlor.
In the context of irrevocable trusts, although the creation and funding of the irrevocable trust have estate and gift tax implications since the ownership and control of the assets are held by the trust itself, the assets typically flow to the beneficiaries outside of the settlor’s federally taxable estate. The growth of the assets from the date of funding escape taxation for Federal Estate Tax purposes.
Trusts can play a critical role in one’s overall financial plan. It is important to find a financial advisor to provide sound financial advice tailored to your specific situation that supports your family’s needs.
About the Author – David Stork
David Stork is a Wealth Director with Bryn Mawr Trust serving the Central Pennsylvania team based in Hershey. David leads an advice-driven cross-functional group of wealth advisors, investment advisors, and relationship managers to deliver extraordinary client experiences. David’s career in the financial services industry spans more than 20 years. He has a high level of technical experience in estate, tax, and financial planning issues. He is a resident of Lancaster, PA.
[i] Trust Definition & Meaning - Merriam-Webster
[ii] What is a Trustee - Trustee Duties and Responsibilities | Trust & Will (trustandwill.com)
[iv] Revocable Trust | The Martin Law Firm (jbmartinlaw.com)
[v] The Importance of Revocable and Irrevocable Trusts In Pennsylvania | David M. Frees III (paestateplanners.com)
This communication is provided by Bryn Mawr Trust for informational purposes only. Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. No portion of this commentary is to be construed as a solicitation to buy or sell a security or the provision of personalized investment, tax or legal advice. Certain information contained in this report is derived from sources that Bryn Mawr Trust believes to be reliable; however, Bryn Mawr Trust does not guarantee the accuracy or timeliness of such information and assumes no liability for any resulting damages.
Most people are not subject to Federal Estate and Gift Tax because its exemption is currently set at $12,920,000, the amount one can give during a lifetime or at death to anyone, free of estate and gift tax.Read More
The world has changed, and so have our households. Life spans are longer – particularly for women – and many families now live off two incomes.Read More
Named after its section in the Internal Revenue Service code, 401(k)’s and other employer-sponsored retirement plans, such as 403(b)’s and 457’s, have become a mainstay for building and saving toward retirement. These retirement plans offer the most comprehensive benefits, from the highest contribution limits to employer matching to unlimited creditor protection, to name a few.Read More
It seems that each day the financial press inks yet another article about an impending US recession. They’ll cite expert sources and provide a slew of economic data backing up their talking points. Investors with a long-time horizon, one that is beyond 10 years, should be content to ride out any market turbulence as a result of the “R” word.Read More
Deciding whether now is the right time to purchase a vacation home depends on various factors, including your personal financial situation, the real estate market conditions, and your long-term goals. It's essential to consult with a financial advisor, or a mortgage or real estate professional, for personalized advice.Read More