- A trust is a contractual relationship
- Trusts may be revocable or irrevocable
- The terms of a trust are as varied as your goals
People often ask about the difference between a revocable trust and an irrevocable trust, and which type should they have. That’s a little like asking, “Which machine should I use, a combine or a forage chopper?” The answer depends, of course, on what you are trying to do.
What is a trust?
Most of us have signed various contracts; they can help us understand trusts. A trust is a relationship created by a contract between two or more parties concerning use and control of property (“property” being anything of monetary value). Their agreement will be specific for the intended purpose. Someone (Trustmaker) proposes terms and another party (Trustee) agrees to those terms. Their agreement then governs how and for whose benefit specified property will be managed.
An individual retirement account (IRA) is a type of trust you create with a financial institution; they hold your investment in trust. You might give a trust deed to a bank to secure a loan. That is an irrevocable agreement concerning the real estate…the bank won’t release it until you pay the note. If you open an account for your grandchild and appoint your child as custodian, you created a trust. You cannot take the money back; it is an irrevocable trust. The custodian (trustee) is bound by law to protect that money for the exclusive benefit of the grandchild.
Trusts in estate planning
In estate planning, a trust is usually used as a way to transfer property, with some kind of time-delay or other conditions. The trust agreement spells out how and when property you own will be given to your beneficiaries such as your spouse or children.
The typical estate planning trust might say that property will be used for someone now, then someone else later. For instance, you transfer property to a trustee (which might even be you, as trustee of your own trust) to use for yourself for the rest of your life. After your death, the trustee (not you, but someone you named when you created the trust) then gives the remaining property to beneficiaries you designated in the agreement.
Irrevocable or revocable?
If you state the above terms in an irrevocable trust, you will not be permitted to serve as trustee, and your ability to change the trust will be severely limited or nonexistent. But in an irrevocable trust you might give someone else the power to make changes. Since control of the property shifts, an irrevocable trust generally has some direct tax impact—some good, some bad—on you or your beneficiaries when the trust is created.
If you use a revocable trust agreement, you are reserving the right to make any changes at any time during the rest of your life. It is an interesting sort of contract, since you aren’t really bound to follow it as originally written. A revocable trust is more like writing a will; so long as you are mentally capable, you can change it. The main difference between using a will and using a trust is the process of carrying it out when you die. Carrying out a will at death involves probate laws and procedures; carrying out the trust terms is a matter of contract law, normally completed without court action.
A revocable trust will have no immediate tax impact on you or your beneficiaries, since you still control the property. Your directions for how property will be distributed upon death can have dramatic tax advantages or disadvantages for your beneficiaries. Estate taxes, capital gain taxes and income taxes may all be implicated and must be considered. Usually where one benefit is gained there is some other benefit lost, so you should carefully consider each trade-off.
So which is better?
Revocable or irrevocable? There is no obvious answer. Some people need both. It depends entirely upon the task you are trying to accomplish! Talk to your attorney about your objectives and let them advise you what “machinery” is appropriate for the job.
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Article authored by Curt W. Ferguson and originally published in the Prairie Farmer magazine, November 2008 issue