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Differences Between Revocable Living Trusts and Irrevocable Trusts

Differences Between Revocable Living Trusts and Irrevocable Trusts

There are a lot of questions and general confusion about the differences between revocable living trusts and irrevocable trusts, which are the two primary types of trusts, and in this article I will explain the key differences by discussing the definitions, uses, benefits and drawbacks of each.  

Defining a Revocable Living Trust

“living trust” is by definition also a “revocable trust” and therefore it is often referred to as one or the other or more holistically as a “revocable living trust”.  If you happen to hear the term “intervivos trust”, this is just a fancy latin term for “living trust”.  A living trust is referred to as “living” because it is created by folks while they are yet living in order to provide a means to avoid probate in Florida and manage assets in Florida in the event of the disability of a loved one.   A living trust has a lot of flexibility and this flexibility is important and yet also results in a few limitations. By flexibility, I mean that a living trust may be revoked or amended at any time by the person/s who established it.

Of course, at the Gibbs Law Office, when we talk about revocable living trusts, we are focusing on a Florida living trust because Florida estate planning is our scope of expertise.  

Using a Revocable Living Trust

The purpose of a revocable living trust is primarily to plan for probate and disability. This is generally a very simple type of trust to administer for these purposes because while the trustmaker is living, he or she is offered ultimate flexibility in making changes or terminating the trust all together.  This kind of flexibility is not offered for irrevocable trusts as we will discuss.  

For example, with a revocable living trust, there is no need for a separate tax id number and no need to register or file the trust anywhere.  This type of trust acts as a holding container for assets and passes title to the assets to the trust beneficiaries upon the death of the settlor/s.  

A revocable living trust may also include important provisions to protect the settlor/s or other beneficiaries in the event of disability.  There are some key revocable Florida living trust benefits that apply when planning in Florida for special needs beneficiaries that can be included in every living trust.  

A revocable living trust does NOT become irrevocable until the death of the settlor/s.  Upon the death of the settlor/s, the revocable living trust transforms into an irrevocable trust, whereby it obtains all of the features and drawbacks of an irrevocable trust to be discussed.

Defining an Irrevocable Trust

An irrevocable trust is by definition not revocable, meaning that this estate planning tool is more difficult to change or undo after being set up by the trustmaker.  In contrast with the flexibility and user friendliness of the revocable living trust, the irrevocable trust in Florida requires its own tax id number.  

A separate tax return is also required every year if income is being generated from the irrevocable trust and if it isn’t, an informational return of some kind is generally still required.  Assets held in an irrevocable trust are taxed at the trust rate, and not the individual trustmaker’s rate, and most of the time this is a higher rate.   

When to Use an Irrevocable Trust vs. a Revocable Living Trust

Given the disadvantages discussed above, why would someone want to set up an irrevocable trust?  There are three primary reasons for preferring an irrevocable trust over a revocable living trust which in simple terms are:  

  1. Asset Protection    
  2. Federal Estate Tax Planning
  3. Medicaid Planning 

Asset Protection in Florida is not available for the trustmaker of a revocable living trust.  The reasons for this range from the fact that it is associated with the trustmaker’s own social security number to the fact that it is a “self settled” trust.  The easy way to understand it is that it is not protected from the trustmakers creditors because it is not a separate entity. 

Thus, asset protection is a primary motivator for people to set up an irrevocable trust. 

Florida Limitations for Asset Protection Trusts

Florida law does NOT provide for a “self settled” asset protection trust OR a trust that someone can set up to protect his/her OWN assets.  So, Florida resident who seeks to set up this type of trust will be required to look to other states such as Delaware.  Under these circumstances, I generally advise clients that unless the trust assets will be fairly substantial (say 1 million liquid) it may be advisable to use other strategies such as using LLCs for asset protection.  

Irrevocable Trusts for Federal Estate Tax Planning 

A common type of irrevocable trust for estate planning is an Irrevocable Life Insurance Trust (“ILIT”) or Wealth Replacement Trust.  This type of Trust is often used for federal estate tax planning because it involves “gifting” money out of the trustmaker’s estate for the benefit of children and grandchildren.

The reasons that irrevocable trusts are effective for estate tax planning go hand in hand with the reasons discussed above for asset protection.  The fact that the irrevocable trust is a separate and distinct entity, allows it to be considered separate from the trustmaker for both estate and income tax purposes.  Although, this can be a disadvantage for income tax purposes when taxed at a higher rate, it can offer a huge advantage for moving assets out of a taxable estate and thereby limiting the size of the estate for limiting federal estate taxes.  

Remember that moving assets out of the trustmaker’s estate naturally leads to “gifting” and other estate tax concerns.  Revocable living trusts, on the other hand, are generally smooth and easily allow for the transfer of assets IN AND OUT and even the termination of the entire trust at any time if desired.

Irrevocable Trusts for Florida Medicaid Planning 

In addition to general asset protection and estate tax planning, irrevocable trusts can be useful for Florida Medicaid planning. For example, an irrevocable income only trust for Medicaid in Florida can be an effective way to transfer assets out of the “countable” estate while preserving an income stream. An irrevocable trust can also be used for special needs planning as a stand alone Florida special needs trust.

Regardless of the type of irrevocable trust, the drawbacks to all are, by definition, that they are much more difficult to change after they are established.  Admittedly, there are a few tricks surmised by savvy lawyers to allow for a bit more flexibility.  For example, you can include the right of the trustmaker to remove and replace the trustee in many asset protection trusts. 

Questions to Consider When Deciding on a Type of Trust

  1. Is your goal estate planning for probate avoidance and disability AND asset protection ONLY for your beneficiaries.
  2. Do you need ASSET PROTECTION for YOURSELF from creditors.
  3. Does your estate size warrant the expense of an asset protection trust OR do you have federal estate tax concerns that may benefit from an irrevocable trust.
  4. Are you prepared to transfer assets out of your estate, and thereby lose a measure of control over those assets.  
  5. Is it possible that you could change your mind about this trust in the future.

If you’re unsure about any of the above, perhaps you should consider a revocable living trust, in Florida or your state of residence, as a good first step. 

Steve Gibbs, Esq.

This is an updated version of an original post dated January 17, 2017. 

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