Revocable Living Trusts – What are They, Benefits and Drawbacks

When many people think of how their assets will be distributed after their death, a last will and testament is typically what they envision. Living trusts provide many benefits, however, and can be a useful tool for many estates.

As you navigate the creation of a trust, you’ll need to choose between the flexibility of a revocable trust and the increased security and rigidity of an irrevocable trust.

Key Takeaways

• A revocable trust is a flexible legal arrangement designed to allocate assets after the owner dies.
• Revocable trusts can be modified at any time, and the owner retains sole control of the assets contained within the trust.
• An irrevocable trust can be a better option for estate planning in some situations, but these additional benefits come with a number of drawbacks.

What is a Revocable Trust?

A revocable trust is a legal arrangement that governs what will happen to certain assets when the creator of the trust dies. There are several reasons to create such an arrangement, but many people use these documents to avoid the probate process after they die.

Generally speaking, trusts can be either revocable or irrevocable. A revocable trust can be modified and updated by the assets’ owner until their death, whereas an irrevocable trust can only be modified with approval from the trust’s beneficiaries and legal administrators.

Benefits of a Revocable Trust

A revocable trust carries many benefits as an estate planning tool. It creates a blueprint for how you’d like your assets managed after you die or are incapacitated, and it offers a great deal of flexibility that certain other financial management strategies do not.

Some of the main upsides to a revocable living trust include:

• Avoiding probate. The probate process can sometimes be complicated and time-consuming, not to mention expensive if an estate is particularly large or conflicts arise. Assets contained in a revocable living trust avoid the probate process, simplifying things for your beneficiaries.

• Privacy. A last will becomes a public record once an estate enters the probate process, while revocable living trusts remain private. For individuals wishing to maintain a level of privacy for their beneficiaries, a living trust can provide some degree of security.

• Flexibility. Unlike an irrevocable trust, revocable trusts can be modified at any time to reflect the changing needs and desires of the trustee. This flexibility makes revocable trusts more appealing to many people who might see irrevocable trusts as overly restrictive.
• Emergency planning. A trust is not only useful as a tool for planning the settlement of your estate after you die—if you are incapacitated, either temporarily or permanently, a revocable trust can grant access to your assets to a trusted individual. Without one of these documents, there could be some challenging legal procedures that must be followed to establish a guardianship or conservatorship.

Key Differences Between Revocable and Irrevocable Trusts

There are a few key differences between the most common types of living trusts, mostly dealing with who can change the terms of the arrangement and when. The primary differences between revocable and irrevocable trusts include:

Flexibility

This is the biggest difference between these two types of trusts—with an irrevocable trust, the management of the assets is no longer under the sole control of their original owner. A revocable trust retains this flexibility and allows the assets’ owner to update the terms of the arrangement at their discretion.

Ownership & Control

Under a revocable trust, the assets’ owner retains full control of them until their death or incapacitation. An irrevocable trust, on the other hand, transfers ownership of the assets to a third-party manager who is tasked with managing them until they are distributed to the previous owner’s beneficiaries.

Asset Protection

One main advantage an irrevocable trust has over a revocable one is the protection of the assets contained within the trust from creditors and other judgments. Under an irrevocable trust, the assets contained in the trust can still be claimed in the event of a lawsuit, divorce settlement or other unexpected debt. An irrevocable trust transfers ownership of the assets away from the original owner, protecting them from seizure in many such cases.

Tax Considerations

Tax liability for assets contained in trusts can be tricky, and it’s always a good idea to consult with a trusted financial advisor about how to structure your estate planning tools to improve your individual tax situation.

Revocable trusts are considered disregarded entities, and the income from the trust flows directly onto its owner’s personal tax return. Irrevocable trusts, on the other hand, are their own taxpaying entity and a dedicated tax return must typically be filed for these types of trusts.

A big tax consideration when choosing between these two types of trusts is the availability of a step-up in basis—generally speaking, a revocable trust will receive a step-up in basis for the assets it contains upon the owner’s death, while an irrevocable trust typically does not confer this benefit. In these situations, the capital gains tax owed by the beneficiaries of an irrevocable trust can be significantly larger than those owed on assets contained in a revocable trust.

Bottom Line

Living trusts can be a powerful investing tool for many individuals, and choosing the right type of trust is an important decision as you consider how your assets will be distributed when you die. A revocable living trust provides a great deal of flexibility while still conferring many of the benefits of a trust by avoiding the probate process and passing along many tax benefits.

If you’re interested in setting up a revocable living trust for some of your assets, Horizons Wealth Management can help you determine the correct steps to ensure you and your family’s financial future.

Revocable Living Trust FAQ