Revocable and Irrevocable Trusts

What makes a trust revocable or irrevocable?

Trusts exist in various forms, and distinguishing between them can initially be challenging. Whether a trust can be changed or cancelled after it has been set up represents one significant distinction, though tax implications and asset protection are equally important factors when choosing a structure.

This difference between revocable and irrevocable trusts affects how the trust operates in practice, who controls the assets, and how the trust is treated for tax purposes.

Revocable trusts

A revocable trust is one where the person who creates it, known as the settlor, keeps the power to change the terms or cancel the trust entirely during their lifetime. This flexibility means the settlor can adjust how assets are managed, change beneficiaries, or dissolve the trust if circumstances change.

Because the settlor retains this level of control, the assets in a revocable trust are still treated as belonging to them for tax purposes. The trust will not reduce inheritance tax liability, and income from the trust is taxed as the settlor's own income.

It is worth noting that revocable trusts do not have the same legal standing or common usage in the UK as they do in jurisdictions like the United States. In the UK, trusts used for estate planning typically need to be irrevocable to offer meaningful tax or legal benefits. Revocable trusts here are occasionally used to manage assets during periods of illness or incapacity, but they offer limited protection from creditors or care home fee assessments since the settlor can technically reclaim the assets at any time.

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Irrevocable trusts

An irrevocable trust works differently. Once established, the settlor gives up the right to alter its terms or take back the assets. The trust becomes a separate legal arrangement, and the assets inside it are no longer considered part of the settlor's estate in the same way.

This permanent loss of control is why irrevocable trusts require careful thought before they are set up. They are often used where the settlor wants to:

• Remove assets from their estate for inheritance tax purposes
• Protect assets for future generations
• Provide for a beneficiary with specific needs over a long period

For inheritance tax, assets placed in an irrevocable trust may fall outside the settlor's estate after seven years, though this depends on the type of trust and specific circumstances. The seven year rule interacts with gift with reservation of benefit rules, meaning that if the settlor continues to benefit from the assets, they may still be included in their estate. HMRC provides guidance on how different trusts are taxed, and current rates and thresholds can be found on GOV.UK.

Irrevocable trusts also carry ongoing administrative burdens and management costs that should be factored into any decision.

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Living trusts and testamentary trusts

A living trust, sometimes called an inter vivos trust, is created while the settlor is alive. A testamentary trust is established through a will and only comes into effect after the settlor's death.

Revocable trusts are always living trusts by their nature because the settlor must be alive to exercise the power to change or cancel them. In the UK, living trusts that remain revocable do not provide inheritance tax advantages, which limits their use in estate planning compared to other jurisdictions. Testamentary trusts are typically irrevocable because the person who created them is no longer able to make changes.

Some living trusts start as revocable and become irrevocable on the settlor's death. This arrangement provides flexibility during the settlor's lifetime while creating certainty afterwards.

Choosing the right structure

Whether a revocable or irrevocable trust is appropriate depends on what you are trying to achieve. Revocable trusts offer flexibility but limited tax advantages under UK law. Irrevocable trusts can be more effective for estate planning, but you cannot undo them if your situation changes.

Professional advice from a solicitor or tax adviser familiar with trust law is sensible before setting up any trust. The Society of Trust and Estate Practitioners and the Law Society can help you find a qualified professional in your area.

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