Irrevocable vs Revocable Trust: Key Differences Explained

Key Takeaways 

• An irrevocable trust is established to help protect assets, access government benefits, and minimize estate taxes.

• Irrevocable trusts may not be amended, modified, or terminated without a court order or the permission of the grantor’s beneficiary. 

• An asset that enters an irrevocable trust becomes independent of the grantor’s taxable estate.

To enhance their estate planning strategies, prospective investors should understand essential aspects of irrevocable trusts. This article explains the fundamental workings of such trusts, the various types, and their benefits.

An irrevocable trust, which is important in estate planning, is a type of trust that is established to help protect assets, access government benefits, and minimize estate taxes.

How Irrevocable Trusts Work

Describe how assets are transferred into the trust, the roles of the grantor, trustee, and beneficiaries, and the legal implications of the trust’s irrevocability.

The grantor establishes the trust then designates a third party to act as trustee and names beneficiaries. The grantor then shifts assets onto the trust, and surrenders ownership rights and relinquishes control to the trustee. Once that occurs, the assets are no longer part of the grantor’s taxable estate.

Since they are “irrevocable,” these trusts may not be amended, modified, or terminated without a court order or the permission of the grantor’s beneficiary. Exact state rules can vary.

Types of Irrevocable Trusts

There are a number of types of irrevocable trusts, including:

— Life Insurance Trust. This is created when someone shifts the ownership of their whole or term life insurance policy to a trust. It reduces federal estate taxes, and allows the grantor to specify how, when, and for whom the death benefit is used. Such a trust can provide the money necessary to cover post-death estate taxes and other expenses. It also enables full leverage of the annual gift tax exclusion— $18,000 per beneficiary in 2024.

For example, a person may have multiple beneficiaries on their life insurance policy. They can name one of them as irrevocable, and by doing so, lock their financial interest in. Because the other beneficiaries are deemed revocable, the grantor is free to modify the policy as they wish.

— Charitable Remainder Trust. With a charitable income trust, the holder can donate assets or money to a charity while providing themselves and their heirs with substantial tax breaks. 

Benefits include the ability to plan major donations to a person’s favorite charities, the provision of steady income for life or a specific period, and the ability to defer taxes on the sale of transferred assets. There may also be a partial charitable deduction based on the value of the trust’s charitable income.

For example, say someone seeks an immediate charitable deduction, but would also like to establish an income stream for themselves or someone else. Such a trust may be an option.

— Special Needs Trust. These trusts seek to improve the life quality of a person with special needs, without impacting the individual’s eligibility for government benefits. Here, the beneficiary gets needed financial support without jeopardizing their eligibility for services or income-restricted programs. The contributor to the trust gains reassurance that proceeds will go to stipulated expenses. 

Pros and Cons of Irrevocable Trusts

As with most anything in the investment or finance space, there are pros and cons when it comes to irrevocable trusts.

Pros:

• Asset protection. Assets in a trust are shielded from lawsuits or creditors.
• Tax benefits. An asset that enters an irrevocable trust becomes independent of the grantor’s taxable estate. No longer is it subject to federal estate tax when the grantor dies.
• Privacy. A trust is a private document that is exempt from the probate process. It is inaccessible to anyone outside the trust.
• Control over distribution. The person who establishes an irrevocable trust must specify how the beneficiary employs those assets.

Cons:

• Loss of control. When assets are placed in an irrevocable trust, that transfer is permanent. The grantor no longer has an interest in, or control over, the assets. 
• Irrevocability. Once assets are transferred into a trust, the grantor may not revoke the trust or undo the transfer. While certain circumstances may permit designated parties to alter specific trust plans, control never reverts to the grantor. Any alterations would have to be done by 100% consent of its beneficiaries or by order of the court, and in some cases both court approval and beneficiary consent may be required.
• Costs. Because these documents tend to be complex to precisely protect the grantor’s interests, they can be pricey to prepare.
• Possible tax implications. Assets that are in an irrevocable trust are subject to taxes, for which the grantor may be responsible, depending on the trust’s structure.

Differences Between Irrevocable and Revocable Trusts

Both irrevocable and revocable trusts help protect the family’s privacy and allows parties to avoid probate court. However, there are key differences between the two types of trusts:

Revocable Trusts 

• Grantors can make changes at will.
• Grantor maintains asset ownership.
• No significant estate tax benefits.
• Limited asset protection from creditors and lawsuits.
• Lacks specific provisions for charity.
• Could impact beneficiary’s assistance eligibility.
• Flexible and easy to set up.

Irrevocable Trusts 

• Cannot make changes without beneficiaries’ consent.
• The trust owns the assets.
• Assets in the trust are excluded from the estate.
• Strong protection since the assets are no longer the grantor’s.
• Supports giving through charitable remainder trusts.
• Protects the beneficiary without affecting benefits.
• More legally complex.

Rules Imposed by the SECURE Act

The SECURE Act, signed into law on Dec. 20, 2019, modified the time frame during which an IRA beneficiary must take withdrawals. In turn, this can affect the account holder’s estate planning efforts.

It may be worthwhile to leave IRA assets to a trust, instead of to individual beneficiaries, since trust language can specify how and when the assets can be distributed to trust beneficiaries.

It is vital for the holder to understand what their estate plan establishes and whether it is aligned with their wishes for their heirs. Strategies with the SECURE Act will depend upon how important control and asset protection is, when compared with tax exposure minimization. A tax professional and estate planning attorney can help.

Who Controls an Irrevocable Trust?

A grantor is the individual who establishes the irrevocable trust and shifts assets or property onto it. They outline the trust’s conditions and terms in a legal document. 

The trustee, meanwhile, must manage and administer the trust according to the grantor’s instructions. Note that the grantor loses control once the trust is established.

What Happens to an Irrevocable Trust When the Grantor Passes Away?

Upon the death of the grantor’s irrevocable trust, the trustee or the individual named successor trustee gains trust control. The assets placed in the trust in accordance with trust bylaws are distributed by the new trustee. 

Specifically, the new trustee must:

• Prepare what is called an Affidavit of Assumption of Duties?
• Alert each beneficiary of the trust’s existence within 60 days of the grantor’s death or 60 days from when they became trustee.
• Obtain an appraisal of the trust assets.
• Distribute trust assets to beneficiaries.
• Submit the grantor’s final income tax return.

Which Type of Trust is Best for Your Needs?

To determine which type of trust is personally appropriate, the individual should take a clear-eyed view of their financial goals and personal circumstances. The type of trust chosen will also hinge on the size of the estate. It is wise to consult with legal and financial advisors about which type to select.

Investing in Alternatives for Retirement 

Estate planning is a crucial component of legacy and retirement planning, which should also include ways to accumulate and grow income. Investing in a retirement account remains a popular option, particularly for the tax favorability.

Pre-retirees who seek diversification and less volatility may want to consider a Yieldstreet IRA. By adding private-market investments to their retirement account, they can maximize the potential for greater returns. After all, the private market has performed better than the S&P 500 in every downturn over nearly the last two decades.

From real estate to art to private equity, alternative investments are not directly tied to public markets. What investment platform offers a broad selection of such assets? Yieldstreet, on which more than $4 billion has been invested to date. 

Footnote: Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

The vast majority of these assets — about 85% — are available for retirement accounts. Yieldstreet also offers a retirement calculator to help determine the amount of retirement dollars needed.

Because Yieldstreet’s program supports all major accounts, individuals may shift all or part of a SIMPLE, SEP, or traditional IRA, or contribute all-new funding.Those with a 401(k) account or multiple retirement accounts may also roll those over.

There is another reason to join Yieldstreet’s IRA: diversification. Establishing a portfolio with varying asset classes can not only potentially improve returns, but it may reduce overall risk.

Alternative Investments and Portfolio Diversification

Alternatives can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.

To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other distinct alternative investments.

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary 

Having an irrevocable trust is an important part of estate planning, which is a key component of retirement planning. Factors such as financial goals, estate size, and personal circumstances should determine the best type of trust for each individual. In establishing a trust, it is smart to consult with legal and financial advisors.

Note: All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information. Diversification does not ensure a profit or protect against a loss in a declining market. This tool is for informational purposes only. You should not construe any information provided here as investment advice or a recommendation, endorsement, or solicitation to buy any securities offered on Yieldstreet. Yieldstreet is not a fiduciary by virtue of any person’s use of or access to this tool. The information provided here is of a general nature and does not address the circumstances of any particular individual or entity. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of this information before making any decisions based on such information.