A Trust is a legal agreement whereby one or more individuals manage property for the benefit of others. There are three major parties: (a) the Trustor (also known as the Settlor or Grantor); (b) the Trustee; and (c) the Beneficiary (or Beneficiaries).
Generally, a Trustor transfers property (monies, real property, etc) into a Trust. The Trust declares that a named Trustee shall manage the Trust property for a Beneficiary. A Trust can have more than one Beneficiary, Trustee or Trustor. Also, one individual can assume two or even three of the roles as Trustor, Trustee and Beneficiary. Usually, the Trust will provide for at least one contingent Beneficiary, who will become an active Beneficiary upon the death of the Trustor. The Trustor (his/her estate) cannot retain the property of the Trust following the death of the Trustor. This would defeat the probate avoiding purpose of the Trust altogether.
Example: Husband and wife, as co-Trustors, transfer property to a Trust with themselves as Co-trustees, with the husband and wife both as life Beneficiaries, and their children declared as the contingent Beneficiaries of the remainder interest.
One Trust can be set-up to create multiple Trusts. For example, a Trust could provide that, upon the death of the Trustors (e.g. husband and wife), individual Trusts shall be created for each child.
So what is the difference between a Revocable Trust and an Irrevocable Trust? Well, one can be revoked and the other cannot. Thank you Mr. Obvious! Seriously though, there are major differences as will be explained below.
The Revocable Trust (The Living Trust)
The Revocable Trust creates a legal relationship where there is a written trust agreement. A Trust of this type is often referred to as a “Trust under agreement”, “Grantor Trust”, or “Living Trust.” As its name implies, it is revocable. Any individual who established the Trust can change their minds and revoke it at any time. The Revocable Trust becomes irrevocable upon the death of the Trustor (since he/she can no longer alter or revoke the Trust). The revocable power of such a Trust is often overshadowed by the federal tax benefits and implications of the Irrevocable Trust (See: below). However, the Revocable Trust does provide an efficient method of avoiding the high costs associated with probate.
The benefit of the control of a Revocable Trust is also weighed down by the legal and tax consequences of the contents of the Trust. Because the Trustor has control (considered as ownership) over the assets of the Revocable Trust, such assets can be reached by creditors or successful parties in opposing litigation. The assets can also be subjected to an estate tax.
The Irrevocable Trust
An irrevocable Trust is a written document where, by its own terms, it cannot be altered after it is established. The Trustee must follow the instructions in the Trust, not those of the people who wrote and funded the trust. The individual who established the Trust (the Trustor) no longer controls the funds. Likewise, the Trustor no longer owns the property that was placed into the Trust. The major benefit of the irrevocable Trust is that the law treats it as a separate "person." The Irrevocable Trust will have its own EIN and must file its own income tax return. Irrevocable trusts are routinely used to reduce federal estate taxes by removing a surviving spouse's control over the assets, but also have other purposes. If the trust is irrevocable, and the Trustor (Grantor) retains no significant control over it, the trust property can be removed from the Trustor's gross estate. Also, the Beneficiary can receive major lifetime benefits under the Trust without having the Trust principal included in that Beneficiary's gross estate.
The major benefit of an Irrevocable Trust is that all of the property in the Trust, plus all future appreciation on the property, is out of the Trustor’s taxable estate. This can provide a lesser estate tax liability, resulting in a more tax efficient way to transfer your accumulated wealth to Beneficiaries. Property transferred to Beneficiaries through an Irrevocable Trust will also avoid probate. As you may know, probate can be very costly (averaging $10,000.00). Additionally, property in an Irrevocable Trust may be protected from creditors and opposing counsel in litigation. The Irrevocable Trust has been used by many financial planners to avoid the Medicare nursing home spend-down provisions whereby if the elderly has to enter a nursing home he/she must first spend all his money until he/she does not have any money left.
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