At first, the difference between a revocable trust and an irrevocable trust may appear very simple. One would think that, as the names imply, a revocable trust is one that can be terminated or amended, while an irrevocable trust is one that cannot be changed. However, as often happens with the law, things aren’t always what they seem as reported in the article “What’s the difference between a revocable and irrevocable trust” from Market Watch.
Sometimes you have to look beyond the name of the trust to determine if it is truly revocable or irrevocable.
A revocable trust, often referred to as a revocable living trust, is one that can be changed or terminated by the person who created the trust, whom we shall refer to as a trust maker. A revocable living trust is often used as a substitute for a Will because, like a Will, it can be amended by the trust maker depending on the circumstances, and it can help avoid probate if the trust maker’s property is titled in the name of the trust (or the trust is named as a beneficiary on the trust maker’s accounts and other assets).
But, a revocable trust becomes an irrevocable trust on the trust maker’s death. Also, the trust maker’s incapacity during life may result in a revocable trust becoming irrevocable. This can be confusing because the trust may keep the same name (for example, the John Doe Revocable Living Trust), but, if John Doe is deceased, the revocable living trust is really an irrevocable trust.
A revocable trust is considered almost an alter ego of the trust maker. As a result, a revocable trust does not provide creditor protection. From a tax standpoint, a revocable trust belongs to the trust maker and is included in the trust maker’s estate when calculating the estate tax.
As for an irrevocable trust, one would generally think that it is a trust that cannot be changed. But this impression, too, may be deceptive. A trust maker, beneficiary, or an independent person may be given powers to make certain changes to an irrevocable trust. Those changes may include the removal and replacement of a trustee and the ability to change or add beneficiaries.
An irrevocable trust is considered to be totally separate from the trust maker. It is usually constructed to avoid having the assets of the trust included the trust maker’s estate for estate tax purposes. An irrevocable trust can offer the beneficiary creditor and divorce protection, as well as prudent management of trust assets if the beneficiary is not good with financial matters. That’s why many parents create irrevocable trusts for their children when making gifts instead of making gifts to their children directly.
In addition to the trust maker giving the power in limited circumstances to change certain provisions of an irrevocable trust, an irrevocable trust may be “reformed” by a court, if it can be shown that the trust’s purposes can no longer be carried out.
And many states have passed laws allowing an irrevocable trust to be “decanted” – meaning that the assets of the original trust may be poured like wine into a new trust that includes provisions that are better suited to the current situation. These laws for the most part include safeguards to make sure that this is not a unilateral decision on the part of the trustee or the trust maker and the decanting is permitted only if it is in the best interests of the beneficiaries.
Of course, a trust maker may always prohibit reformation or decanting when creating an irrevocable trust, but, if the trust is to last for generations, it may make sense to allow limited ways for the irrevocable trust to adapt to changing circumstances.
So the next time you come across a reference to a revocable or irrevocable trust, look beyond the name to determine whether the trust is really revocable or irrevocable.
Reference: Market Watch (Oct. 8, 2021) “What’s the difference between a revocable and irrevocable trust”