A trust is a legal instrument where one person (the trustor) grants another person (the trustee) the legal right to hold title of assets for the benefit of a third party (the beneficiary). Depending on the type of trust, they’re often set up for a number of purposes, including:
- Creditor protection: Certain types of trusts can protect assets from creditors and lawsuits.
- Asset safekeeping: A trust is a legal entity that holds property, and as such it can be a safer choice than simply giving assets to a relative or other individual who could lose them in a legal entanglement like a lawsuit or divorce.
- Tax shelter benefits: Certain trusts allow assets to transfer to beneficiaries without being subject to estate taxes.
- Privacy: The terms of a will may be public information depending on where you live, whereas the terms of a trust can remain private.
- Estate planning: Trusts allow minor children to receive assets with the stipulation that a trustee manages those assets until the child reaches adulthood.
- Incapacity: A trust can allow a person you designate to step in and manage your assets in the event you become incapacitated without having to petition the court for guardianship.
An Important Decision, No Matter Which Type You Choose
There are many different types of trusts, but one of the main differentiators that allows a trust to function for different purposes is whether that trust is revocable or irrevocable.
One can alter the terms of a revocable trust at any time. The owner could decide to eliminate or add beneficiaries and modify the terms under which assets are managed.
While this offers flexibility, it also greatly limits some of the benefits trusts can offer. Typically, revocable trusts do not confer tax shelter benefits or protection from creditors. In many cases, however, they can avoid the probate process and provide greater privacy than a will.
An irrevocable trust, on the other hand, cannot be changed once it’s established except under very rare circumstances. And any changes generally require the intervention of a judge and the consent of all parties involved. You’re permanently giving up control of your assets by placing them in an irrevocable trust. This is why it’s important to be very certain that your needs or reasons for establishing an irrevocable trust are not likely to change over time.
Irrevocable trusts require serious contemplation, but they can offer a number of advantages over revocable trusts, including protection from creditors and lawsuits, tax shelter benefits and asset protection from Medicaid. In essence, there is a direct tradeoff between control of assets and the benefits and protection a trust offers.
Sources
Thebalance.com, The Pros and Cons of Revocable Living Trusts
Investopedia.com, Revocable Trust vs. Irrevocable Trust: What's the Difference?
Money.usnews.com, Choosing Between Revocable and Irrevocable Trusts