When deciding between a revocable vs. irrevocable trust, one will need to consider their net worth and what type of tax shelter their heirs may need. It may be tempting to set up a will and consider your estate planning complete, but trusts are critical for organizing how your assets are distributed during your lifetime and after death. Both types of trusts have pros and cons that can have a significant impact on one’s estate and beneficiaries.

Revocable vs. Irrevocable Trust

How do you decide which one is best for you and your family? Both types avoid the dreaded probate process when a court manages the distribution of your assets after death. Probate can be costly, lengthy, and public; and both types also require a trustee to manage the trust, a legal entity that governs the treatment of your real estate, investments, cash, and other assets.  Our Financial Advisors can help you decide on the type of trust to set up to help you accomplish your goals!

Revocable Trust: The People’s Choice

As its name suggests, a revocable trust, also called a revocable living trust, gives you the right to make changes to or terminate the trust in your lifetime. Its biggest feature is the flexibility and control it gives the grantor — or you, the asset owner. The biggest drawback is that assets in the trust are still counted towards income and estate taxes. It also is not protected from creditors, legal judgments, liens, and other obligations.

Some people choose to set up revocable trusts unless they are high-net-worth individuals seeking to maximize their estate and gift tax exemption.

For 2024, assets up to $13.6 million per person ($27.2 million for a married couple) are exempt from federal estate and gift taxes. So, if an individual person’s estate is worth $20 million, they might choose to put $7 million in an irrevocable trust. The remaining $13 million can be held in a revocable trust and is exempt from federal estate and gift taxes since it falls under the cap. However, they still must pay income taxes on it. (Currently, twelve states and the District of Columbia also levy estate taxes.)

Typically, the owner or grantor is also the trustee of the revocable trust, although others can also be named as trustees. A married couple can be co-trustees so that when one spouse becomes incapacitated or dies, the other can carry on. When both have died, the trust becomes an irrevocable trust.

Irrevocable Trust: Is It Really a Tax Shelter?

An irrevocable trust is one in which the grantor gives up the ability to control or benefit from the trust assets once the trust is set up. People may choose this type of trust if they have a specific purpose for the funds, such as controlling the payout to beneficiaries, designating the funds for a purpose, and protecting assets from liens, legal judgments, creditors, divorces, and other obligations.

Due to state law changes in past years, it has become easier to change irrevocable trusts. It is a bit of a misnomer that an irrevocable trust cannot ever be changed. You can, but it depends on the situation.

One way is the designation of an independent trustee to make changes consistent with the grantor’s wishes. Another way is to give a beneficiary the power to appoint or redesignate the recipient of trust assets. The court also can order changes to a trust — or trustees can do what is called ‘decanting’, moving assets from an old trust to a new one with better terms and conditions, as long as the changes are reasonably consistent with the original intent of the trust.

An attractive benefit of an irrevocable trust is that the grantor does not pay taxes on it; the trust can pay its own taxes without distributing its income. Alternatively, the trust can choose to give the income to beneficiaries, who will be the ones to pay taxes. This might be a better option if the beneficiaries fall into a lower tax bracket.

That is because the taxes levied on the trust can be at par with the highest income tax rates. Within the trust, any ordinary income above $15,200 falls into the 37% marginal tax bracket. In contrast, the 37% rate does not kick in for income taxes until $609,350 for a single taxpayer or $731,200 for joint filers.

Beneficiaries with disabilities may need another type of trust, which can be revocable or irrevocable. These trusts provide for disabled beneficiaries without jeopardizing their government benefits. Business trusts that hold business interests, among others. Life insurance trusts, which hold proceeds from insurance policies, are also fairly common but are irrevocable.

States with the most favorable trust laws

A trust created in one state is valid in all other states. However, each state has its own rules that apply to trusts. You can set up a trust in any state in which you have sufficient connections, such as having a vacation home in that state. In general, look at each state’s tax treatment of trusts, asset and creditor protection, privacy, and modification rules.

The best states for trusts are Nevada, South Dakota, Delaware, Alaska, and Wyoming according to Vann Equity Management; because they do not charge state income taxes, offer perpetual trusts that are passed down through generations indefinitely, and provide asset protection and flexible decanting.

However, if the trust elects to shift the tax burden to beneficiaries, these favorable tax laws will be moot if beneficiaries do not live in these states.

Contact Alan Mapels for more information on how you can set up which trust is right for you.

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Disclosure

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The information herein should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.  Tax laws and regulations are complex and subject to change, which can materially impact investment results. Additional tax rules not discussed herein may also be applicable to your situation.  This material should not be regarded as a research report.  Forward-looking statements should not be considered as guarantees or predictions of future events.

Past performance is no guarantee of future results.  Any views or strategies discussed in this material may not be appropriate for all individuals and are subject to risks.  All investments are subject to risk, including the possible loss of the money you invest.

The data and information set forth in this presentation has been compiled and prepared from sources we believe to be reliable, however, we make no representations, warranties or guarantees as to its accuracy or completeness, nor has it been reviewed, approved or verified by the Securities and Exchange Commission or any state securities regulatory agency. However, its accuracy, completeness or reliability cannot be guaranteed. The information contained herein is not to be construed as a solicitation or an offer to buy or sell any securities, or related financial instruments Vann Equity Management disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources.

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