Types of Trusts: Revocable, Irrevocable, Living, and Testamentary
Trusts are commonly used in estate planning. Although they come in different varieties, some common trust factors to consider include the use of a revocable vs. irrevocable trust, as well as whether the legal agreement is a living or testamentary trust. These concepts play a key role in how the trust operates in one’s estate plan.
Revocable Trusts and Irrevocable Trusts
Provided you understand the basics of trusts, you'll need to consider the type of trust that best serves your purposes.
An important factor to consider is the flexibility of a trust's provisions, but this must be balanced against your income and estate tax objectives. The complexity of the tax code makes it nearly impossible to have your cake (or keep your hands on your money) and eat it too (protect it from taxes.)
A revocable trust is exactly what the name implies: It is a trust that can be amended or revoked by the grantor after it is created. In contrast, an irrevocable trust cannot be amended or revoked by the grantor after it is created.
A revocable trust becomes irrevocable upon the grantor's death, since the grantor is no longer able to change or revoke the trust.
Trusts designed to avoid federal estate taxes are often drafted to be irrevocable (but not always, as in the case of the bypass trust), while trusts designed only to avoid probate court frequently are revocable. However, there can be significant income tax consequences along the way, so it is important to work with a professional to avoid unpleasant surprises.
Living Trusts and Testamentary Trusts
Besides revocability, you'll need to consider the timing of the transfer and the associated implications.
A living trust (sometimes called an inter vivos trust) is one created by the grantor during his or her lifetime, while a testamentary trust is a trust created by the grantor's will.
Only a funded living trust avoids probate court. In a testamentary trust, property must pass into the trust by way of the will and, thus, must go through the probate court process.
Similarly, an unfunded living trust technically does not exist until it receives some assets. If you attempt to create a living trust but do not transfer any assets to it except through your will, the property must go through probate just like a testamentary trust.
Avoiding probate court, and the costs and delays associated with this process, is a distinct advantage of the living trust. On the other hand, funding of the living trust means that the grantor must transfer assets into the trust during his or her lifetime, and provide for management of those assets by a trustee. This creates its own burdens.
These burdens can be lessened when the grantor also acts as the trustee. However, in some instances, this can cause the trust's assets to be included in the grantor's taxable estate and may have income tax consequences. In many cases, an estate planning attorney can structure the trust to prevent distasteful outcomes.