Clients are often understandably confused about the differences between revocable trusts, irrevocable trusts, and testamentary trusts. Very simply, testamentary trusts are those created pursuant to one’s last will and testament. Such trusts do not get established until the death of the person who created the will, and the provisions which govern the trust are contained in the will itself. These are usually created for the benefit of minors, spouses and disabled children. These trusts can be changed by the testator at any time, but they become irrevocable at his or her death.
A revocable trust is created during the maker’s lifetime, by a separate document. Revocable trusts, also commonly referred to as living trusts, can be amended or revoked at any time by the maker of the trust (the “grantor”). Only upon the death of the grantor does the trust become irrevocable. The primary purpose of the revocable trust is to avoid probate. In order to accomplish this purpose, all assets of the grantor must be transferred to the trust during the grantor’s lifetime. Contrary to what is often discussed at revocable trust seminars, these trusts do not accomplish any tax savings, nor do they protect assets in the event one needs long-term health care.
Irrevocable trusts are also created during the grantor’s lifetime, by separate documents. There are many types of irrevocable trusts and their primary purpose is to achieve tax savings, prevent disabled beneficiaries from losing government benefits, and/or protect assets from long-term health care costs, while also avoiding probate. They are often used in the case of second marriages, to allow a surviving spouse to receive income from the assets but ensure that upon the death of the surviving spouse, the assets pass to the grantor’s children. Irrevocable trusts, by definition, may not be amended or revoked by the grantor. Moreover, they necessarily entail some loss of control by the grantor over the assets transferred to the trust. Of course, there are many types of irrevocable trusts. For example, if one’s primary goal is to avoid or reduce estate taxes, one can establish a qualified personal residence trust, a grantor retained annuity trust, or a charitable remainder trust, to name a few. Life insurance trusts are extremely useful, as they remove the entire value of life insurance proceeds from one’s taxable estate. As is the case with all irrevocable trusts, the grantor may not act as Trustee of these trusts, nor exert any control over the trusts.
Prior to establishing any type of trust, one should first give serious thought to what objectives one is looking to achieve. Obtaining advice from an attorney who is knowledgeable in the areas of taxation and estate planning will prove invaluable.
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IRS Circular 230 disclosure: We inform you that any tax advice contained in this communication is not intended or written to be used, and may not be used by your or anyone else for the purpose of avoiding penalties imposed under the Internal Revenue Code.