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Choosing between a revocable and irrevocable trust is akin to selecting the right tool for a job—it all depends on what you’re trying to achieve. This article will help you navigate the nuances of each option, revocable vs. irrevocable trust so you can make the choice that best aligns with your goals.

What is a revocable trust?

Think of a revocable trust as your flexible tool. You can create the revocable trust, reserve the power to change the revocable, and reserve the power to revoke (terminate) the revocable trust. This flexibility can come in handy as your life circumstances evolve. It’s like having an editable document for your assets, where you retain control and can make adjustments as needed. The flexibility of a revocable trust is usually not worth giving up unless some other goal has a higher priority than flexibility. 

What are the  primary advantages or uses of a revocable trust? Avoiding probate process, maintaining privacy, and ensuring smooth management of your assets if you’re unable to do so yourself.

What is an irrevocable trust?

An irrevocable trust is a legal arrangement where the grantor transfers assets into the trust, relinquishing ownership and control over them. Once established, the trust’s terms cannot be easily altered or revoked. This permanence is what defines the irrevocable trust and distinguishes it from its more flexible counterpart, the revocable trust.

The irrevocable nature of the trust means that once it is set up, the grantor has very limited ability to change its terms or reclaim the assets. This requires a high level of commitment and certainty about the trust’s purpose and the assets placed within it.

Why would I want an irrevocable trust? 

Now, I know what you’re thinking: “Why on Earth would I give up control over my own assets?”Irrevocable trusts can be useful for asset protection, tax planning, medicaid planning, long term care planning and legacy planning. 

Asset Protection

Irrevocable trusts offer a high level of asset protection. Once assets are transferred into the trust, they are legally owned by the trust and usually have a greater level of protection from creditors lawsuits, and judgments against the grantor. Irrevocable trusts can be a valuable tool for individuals concerned about liability, losing assets earmarked for long term future investment and protecting assets from potential future legal claims.

Tax Benefits

Transferring assets into an irrevocable trust can reduce the size of the settlor’s (the trust creator’s) estate, potentially lowering estate taxes upon the settlor’s death. The intent is typically to remove assets from ownership by the settlor, and thereby avoid inclusions of the trust assets in the settlor’s estate valuation for estate tax purposes. This can result in significant tax savings, especially for estates that exceed federal tax exemption thresholds.

Medicaid Planning

Irrevocable trusts can be structured to exclude certain assets from being counted against the settlor’s eligibility for Medicaid. This allows individuals to avoid losing their assets to long-term care costs and to qualify for Medicaid. Properly structured irrevocable trusts can preserve wealth for beneficiaries, ensure the settlor receives necessary care and provide the family additional funds to supplement the care provided by Medicaid.

Legacy Planning

Irrevocable trusts provide a mechanism for detailed legacy planning. The grantor can specify how assets within the trust are to be distributed or used, such as funding education for grandchildren or supporting charitable causes. This allows for a controlled and intentional distribution of the grantor’s wealth according to their wishes.

What are the downsides of a revocable trust?

The revocable trust offers you the luxury of control, allowing you to make changes as your life and wishes evolve. However, this control comes without the enhanced asset protection and tax benefits provided by an irrevocable trust.

With a revocable trust, you retain control over the assets and can alter or dissolve the trust at any time. This flexibility, however, comes at a cost. Because you can reclaim these assets, they remain within your legal reach, making them accessible to creditors and legal judgments.

Since you maintain control over the assets of a revocable trust, these assets are still considered part of your estate for tax purposes. Therefore the revocable trust offers no estate tax benefits upon your death. However, at the time of this writing, the estate tax exemption is large enough that, for the majority of the population, estate tax benefits are not a consideration for estate planning.

The revocable trust, with its assets still under your control, does not typically exclude assets from being counted for Medicaid eligibility in Alabama. Assets within a revocable trust could still count against you, potentially impacting your eligibility for Medicaid assistance.

How do I choose between a revocable and irrevocable trust?

When deciding between a revocable and irrevocable trust, consider the following factors:

Control vs. Protection: If maintaining control over your assets during your lifetime is more important to you, a revocable trust is likely your best bet. However, if you’re more concerned with protecting your assets from creditors, legal judgments, or reducing your taxable estate, an irrevocable trust might be the way to go.

Estate Size and Taxes: For those with larger estates, the potential tax advantages of an irrevocable trust can be beneficial. By removing assets from your estate, you may reduce or eliminate estate taxes, providing a financial benefit to your beneficiaries.

Medicaid Planning: If qualifying for Medicaid without depleting your assets is a priority, an irrevocable trust can be a strategic choice. Assets placed in certain types of irrevocable trusts ahead of time may not be counted against you for Medicaid eligibility purposes.

Flexibility Needs: Life is unpredictable. If you anticipate significant changes to your financial situation, family dynamics, or estate planning goals, the flexibility of a revocable trust could be invaluable. Or, if you do not perceive any value from an irrevocable trust, retaining the flexibility of revocable trust is the smart move whether you expect to need it or not.

If you would like our help with estate planning, please call us at (251) 215-9275 or write us on the contact page.