Revocable vs. Irrevocable Trusts: Which one is best for you?

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A personal trust can be an indispensable tool for anyone with significant assets and a desire to influence or direct how those assets should ultimately be distributed. While there are many varieties of personal trusts, all fall into one of two categories: revocable or irrevocable.

Fifth Third’s trust and estate planning professionals explain the differences between each type of trust, their benefits and which trust best suits your needs.

The difference between revocable and irrevocable trusts

The main difference between them is control. With a revocable trust, the owner retains control over the assets in the trust, and there are no immediate estate tax benefits. With an irrevocable trust, the grantor cedes control of the assets to a trustee, which allows the assets to be moved outside the estate for tax purposes and provides protection against creditors.

"For most families, a revocable trust will be a core part of their estate plan and can yield a range of benefits," says Jeff Miller, senior wealth strategist at Fifth Third Private Bank. "Later on, you may wish to add an irrevocable trust based on your specific circumstances."

What is a revocable trust?

As the term suggests, a revocable trust can be revised at any time for any reason. That degree of control and flexibility can be critical. As your family’s circumstances evolve through marriage, divorce or the birth of children and grandchildren, for example, you may want to rethink the terms of the trust, add or remove a beneficiary, reallocate the distributions or even revoke the trust altogether and rewrite it from scratch.

"With a revocable trust, you’re in total control," says Miller. "What’s more, assets in the trust will go directly to your beneficiaries, avoiding the need for probate court, where proceedings are part of the public record, and keeping the trust distributions private."

Revocable trust benefits

While a revocable trust usually offers no immediate estate tax benefits, there can be deferred benefits. If a revocable trust owns assets that are worth more than the grantor’s remaining estate tax exemption amount, then at the grantor’s death, the revocable trust can create additional sub-trusts that work together to minimize estate taxes. A classic example of this is when a family trust and a marital trust are created at the grantor’s death.

What is an irrevocable trust?

Such considerations may have less relevance where irrevocable trusts are concerned. The reason is that irrevocable means just that—once the trust agreement is finalized, it may be extremely difficult, if not impossible, to change the terms or beneficiaries.

Irrevocable trust benefits

With an irrevocable trust, while you give up the option to change the terms of the trust in the future, you gain significant potential estate tax savings. Assets placed in an irrevocable trust are removed from your estate, potentially reducing the estate tax burden on your heirs. This can be a significant benefit for business owners or investors whose estates exceed the federal estate tax exemption.¹ "Unless your estate and prior gifts exceed that threshold, your heirs won’t have any estate tax liability, thus eliminating a key reason to have an irrevocable trust," Miller points out.

Potential tax benefits

If you set up an irrevocable trust for charitable purposes, you may also be eligible for an immediate income tax deduction when you place assets in the trust, which you can use strategically for philanthropic purposes during the life of the trust.

In some situations, it may also be advisable to purchase a life insurance policy and place it in an irrevocable life insurance trust (ILIT). Since the proceeds from the policy will fall outside your taxable estate, an ILIT can provide your heirs with the liquidity to pay estate taxes without having to quickly sell a family home, business or other illiquid assets to pay estate taxes which are generally due within nine months of the date of death.

Other types of irrevocable trusts to consider include a special-needs trust, which lets a family set aside money for the lifetime care and support of a disabled dependent. You can also use an irrevocable trust to gift assets to your children, grandchildren or future generations and stipulate how those assets are to be used.

The case for a revocable trust

These are specialized scenarios, however. Unless they reflect your specific goals and priorities, the benefits of an irrevocable trust may be of little value when measured against the loss of control and flexibility. "For most people," Miller says, "revocable is the more appropriate choice for your core estate planning."

The main reason for setting up a revocable trust is to avoid having your estate go through the probate process, which could likely be required if you only had a standard will. Not only does this streamline the administration of your estate (especially if you have assets in numerous states), but it keeps the terms of your estate private, such as how much you bequeathed to each of your heirs. Wills that go through probate court are made public.

Complex rules require specialized advisors

Whether revocable or irrevocable, a trust agreement must be drafted with close attention to the laws and regulations, which are complex and can vary not only from year to year, but from state to state. This is why it is essential to work with an attorney who specializes in trust and estate law rather than a lawyer who normally handles, say, business matters, Miller says. Then, once your trust is set up, it’s important to review it every three to five years and discuss any needed modifications with your advisors.

The selection of a trustee to administer the trust is also critical. "It may be tempting to choose a family member who you think knows your intentions and will act in the best interests of you and your beneficiaries," says Miller, "but the job involves a heavy load of financial and legal recordkeeping and tax management, not to mention specialized knowledge of these areas." For this reason, partnering with a corporate trustee like Fifth Third Private Bank can be beneficial, as their team of estate and trust professionals can ensure your wishes are carried out throughout the life of the trust.

Although some people shy away from creating an estate plan because they don’t want to contemplate their passing, it is crucial to have discussions with your family and advisors while you’re still young enough to make thoughtful and intentional preparations. "Once you begin the dialogue with your attorney, you’ll find that establishing a trust can be a deeply satisfying experience," Miller says. "A trust is a gift to your loved ones and to future generations."

Choosing the appropriate trust as part of your estate planning can ensure that your heirs have sufficient financial protection and privacy, while keeping your estate management out of the often long, complex and costly process of probate.

For more information on deciding which trust is right for your unique situation, contact your Fifth Third Private Bank advisor.