We are often asked the difference between irrevocable trusts and revocable trusts. They are both part of the estate planning toolbox, but have entirely separate uses. In short, revocable livings trusts (RLT) are primarily used to bypass the probate process and do not protect assets from creditors.
There are a variety of irrevocable trusts. Here we will focus on irrevocable income only trusts (IIOT), or Grantor’s trusts, as they are the preferred method for protecting assets from Medicaid. Here are seven salient differences between the two trusts.
1. Property Ownership
Assets transferred into an irrevocable asset protection trust no longer belong to the settlor; rather, the assets are owned by the trust. This does not exclude one from living in “their” house or driving “their” car simply because it’s now formally owned by the trust, it merely means you don’t own it, not that you cannot still benefit from it.
Similar to renting or leasing, you may still use the assets as you see fit, but you may also buy, sell and live1 off the income it provides. A properly formed and funded trust fund provides the best possible protection of assets from creditor claims because you don’t own the asset. Thus, creditors may not attach a judgment to the asset any more than they may seize your neighbor’s home. The assets quite literally change owners.
This is vitally different from an RLT wherein the grantor maintains ownership.
An irrevocable trust agreement is significantly more difficult to modify or revoke, even with a court order. This limitation is what enables the sought after asset protection. Our trusts, however, still enable you to amend the designated beneficiaries without effecting the benefits you desire.
Revocable living trusts, on the other hand, are structures that may be changed at the Grantor’s discretion at any time. This difference means the trust’s assets are accessible, for both the grantor and the grantor’s creditors. The dictionary definition of ‘irrevocable’ scares people into thinking the trust may not be changed no matter what. This is not the case:
As the Grantor does not own the assets in a trust, the trust is not included in your estate calculations when you pass away. Revocable trusts, though, are designed to avoid probate, but do no assist with minimizing taxes. This is because you still have full control over the assets and thus they are included in your death estate and Medicaid estate.
4. Protecting Assets
The assets in an irrevocable trust no longer belong to the settlor, they are thus considered to be owned by a “3rd party” and are generally protected from creditors, lawsuits and the government, so long as the original transfers were not fraudulent. This structure affords an extra degree of protection from those seeking to seize your assets.
An Irrevocable Income Only Trust (IIOT) is our recommended structure for avoiding Medicaid’s asset and income test. Generally, the senior person in need of specialized care must exhaust their resources before qualifying for Medicaid provisions. These spend down provisions can whittle away your life’s work and leave your heirs with nothing.
Let’s contrast this with a revocable structure. A revocable structure is subject to Medicaid clawbacks because the initial transfers were not exempt due to the assets still being under your control. Such assets as thus still available for settling liabilities.
5. Strategic Medicaid Planning
With irrevocable trusts, a prime benefit of elder planning is enabling the elderly to qualify for Medicaid benefits should they require specialized long term care, e.g. a nursing home. Through transferring assets into an irrevocable trust five years ahead of needing care, the settlor secures his beneficiaries inheritance from claims. Again, this strategy is meaningless with regards to revocable trusts because Medicaid does not consider the holdings of such trusts to be “exempt assets”.
6. Trustee Appointments
There is a common conception the trustee of your IIOT must be 3rd party, preferable one who is independent. Our Medicaid Asset Protection Trusts, however, allow YOU to be the trustee. These trusts are also known as self-settling because of this feature. Note, whomever is the trustee has a fiduciary duty to protect the assets and act in the best interests of the beneficiaries.
The Trustee, regardless of who, is tasked with managing the assets in the trust and is bound by the provisions you set forth. Note, the “Income Only” portion of the IIOT means you may live off the income produced by the assets.
7. Income Tax Return
Our Medicaid Asset Protection Trusts have their own tax identification number (TIN/EIN) and files a 1041 with the Internal Revenue Service. The trust may then either pay the tax directly (atypical) or issue a K-1 to the Grantor/Beneficiaries for income that passes through to the recipient’s via a Schedule E.
RLTs, though, have no such discrepancy given they are disregarded entities for tax purposes. The Grantor files everything on their 1040 because they personally own the assets which are "held" in the trust.
Reviewing the differences between irrevocable and revocable structures makes clear the former is for protecting assets whereas the latter is meant to bypass probate.
The assets are protected from estate taxes because they are outside the death estate at the time of passing, from creditors, including Medicaid, because you do not own them. This benefit comes with certain restrictions, such as only being able to live off the asset’s income, but is often well worth the trade off.
Conversely, the revocable living trust simplifies the transferring of assets to beneficiaries through avoiding the probate process, but provides no other protections.
Laws change and are more complex than we can represent here. For these reasons, we recommend consulting with an expert before embarking upon significant estate planning decisions.
A revocable living trust is an estate planning tool that allows you to avoid expensive and time-consuming court proceedings. Imagine placing all your assets into a box to which you and only you have the key. The box is the living trust. It is a separate legal entity that holds all your assets. You and your spouse are the trustees of the trust, meaning you control the trust and everything in it.
A living trust does more than just hold your assets. It contains your instructions, guidelines and blueprints for how you want your assets passed to your loved ones when you die and how you want you and your family to be cared for in the event you become incapacitated.
A living trust also designates whom you want to take over as trustee when you die or if you become incapacitated. At that point, your handpicked trustee takes legal control of your assets, protecting you and your family from court control of your affairs.
Also, your trust is revocable, meaning that you can modify or cancel it at any time.
(And you never need to file a separate tax return.)
Doesn't a will accomplish the same things as a living trust?
If you only have a will, court probate proceedings will be necessary to transfer your assets to your family after you die. With a revocable living trust, no probate proceeding is necessary.
Also, a will does not become effective until you die, so it cannot take care of you if you become incapacitated. A court will have to get involved to appoint a conservator to take care of you and your financial affairs. A living trust includes your plans for you, your family and your finances during your potential incapacity, making court involvement unnecessary.
Why do I want to avoid probate?
Probate freezes your assets. If your estate ends up in probate, the bulk of your assets are frozen until the court orders their distribution, which typically takes at least nine months and frequently more than a year. With a revocable living trust, distributions to your loved ones can usually be made almost immediately.
Probate exposes your affairs to interested parties. Court proceedings are public. Probate proceedings could expose your financial information to economic predators and disgruntled heirs. With a revocable living trust, your privacy is protected.
If I became incapacitated, couldn't my spouse take care of everything?
If you become incapacitated and haven't designated someone to take care of your financial affairs, your family will need to petition a court to appoint a conservator. Even if your spouse becomes your conservator, he or she will be subject to ongoing court supervision. No one - not even your spouse - will have the right to make legal or financial decisions for you without a court's permission.
While a durable power of attorney can be used to appoint someone to handle your affairs in the event you become incapacitated, many banks and financial institutions will only recognize a durable power of attorney on their own form.
If you have placed all of your assets in a revocable living trust, your spouse or other hand-picked trustee will have legal title to the assets if and when you become incapacitated. That way, your trustee's authority to manage your assets cannot be questioned, and there will be no need for court involvement. A well-drafted living trust will also spell out guidelines for your trustee to follow as to how you want your assets handled during your incapacity - so, in effect, you maintain some control even during your incapacity. And, unlike a will, a revocable living trust becomes effective as soon as you sign it - so it's there to protect you whenever you need it.