It can sometimes appear difficult to differentiate between different types of trust. In some cases, different trust types share many of the same characteristics. However, one of the key distinctions that can be made concerns revocability; this can have significant implications for both the legal and tax treatment of the trust.
Revocable and irrevocable trusts are used for very different reasons, and in very different circumstances. As is suggested by the name, a revocable trust allows the settlor to alter the terms of the trust, or cancel it altogether, within his or her own lifetime.
An irrevocable trust, on the other hand, is set in stone upon its establishment; after that point the terms of the trust cannot be changed, and the trust cannot be revoked.
Living & Testamentary Trusts
By definition, revocable trusts must be living (also known as inter vivos) trusts. This term describes a trust that is established during the lifetime of the settlor, as opposed to one that is established posthumously. The latter type will generally be established as a result of provisions made in a will; the settlor is therefore known as the testator in these cases. If the settlor is to have the power to revoke or amend the trust, it must clearly be established during their lifetime.
Irrevocable trusts, on the other hand, can be established either during the settlor’s lifetime or after their death. There are a number of reasons why it may be advisable to establish an irrevocable living trust. Primarily, revocable and irrevocable trusts are treated very differently for tax purposes. In a revocable trust, the settlor can continue to directly draw benefit from the assets that have been transferred.
A house could be placed in trust, for example, and the settlor would continue to be able to live in it. As such, any income that is derived from the assets in trust continues to be taxed as if it were part of the settlor’s estate. This means that there is frequently no immediate tax benefit to the settlor in establishing a revocable trust.
In certain types of revocable trust, however, the settlor gives up both legal and practical ownership of the assets and, as such, they cease to be counted as part of the estate. Thus, irrevocable trusts can be used to mitigate a tax liability while the settlor is still alive.
Estate Planning
Revocable trusts, however, are useful estate planning tools. While the settlor tends to be the sole beneficiary while they are alive, it is possible to make provision for a successor beneficiary who will derive benefit from the assets after the death of the settlor. As the legal title to the assets has been given up, they can be passed directly on to the settlor’s intended heirs. As such, a revocable living trust provides a useful opportunity to avoid the probate process, which can be lengthy and expensive. Further information on probate avoidance and living trusts is available elsewhere on this site.
As with any decisions regarding trusts, it is always a good idea to seek independent legal advice when considering whether a revocable or irrevocable trust is the best solution in your circumstances.
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