How Do Trusts Work?

Revocable Trusts vs. Irrevocable Trusts | What is the Difference Between a Revocable Trust and an Irrevocable Trust?

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Updated on:
November 9, 2018

In this article, we will explain the difference between revocable trusts and irrevocable trusts in Illinois.  We will answer the questions, how do trusts work?, what is the difference between a revocable living trust and an irrevocable trust?, what is a revocable living trust used for?, and what is an irrevocable trust used for?  We will also discuss how irrevocable trusts are used to protect assets from creditors, to plan for long-term care, and to minimize estate tax.

How Do Trusts Work?

A trust is a document that creates a legal entity that can own property in a manner distinct from the creator of the trust.  The creator of the trust is known as the “grantor.”  The grantor of the trust will typically name several trustees who are responsible for acting in succession to manage the assets of the trust for the benefit of the beneficiaries named in the trust.  The trustee has a fiduciary duty to manage investments and distributions according to the terms of the trust that are set forth by the grantor in the trust document.  

If one trustee passes away or becomes unwilling or unable to act, the next trustee in the line of succession will take over trustee duties.  The beneficiary of the trust can also change during the life of the trust based on triggering events that are set forth in the trust document.  

The trust document does not set forth the property the trust owns.  Rather, the title to the property that the trust owns is changed to indicate that it is owned in the name of the trust as opposed to being owned in the name of the grantor individually.  

What is the Difference Between a Revocable Living Trust and an Irrevocable Trust?

A revocable living trust can be modified at any time by the grantor.  An irrevocable living trust involves the grantor giving up some rights to his or her property without the automatic ability to take those rights back whenever he or she would like.  

For this reason, property owned by a revocable living trust is treated as the grantor’s own property for many purposes, such as income tax and estate tax. On the other hand, property owned by an irrevocable trust may no longer be considered property of the grantor, depending on the terms of the trust.  

What are Revocable Living Trusts Used For?

Revocable living trusts are used for basic estate planning.  Often they serve many of the same functions as a will.  For more on the difference between revocable living trusts and wills check out our article, Wills vs. Trusts in Illinois.  

Like wills, revocable living trusts can provide for the distribution of assets when you pass away.  Unlike wills, revocable living trusts will ensure that your estate does not go through probate when you pass away.  For more on what probate is, why it is preferable to avoid probate, and how revocable living trusts work to avoid probate, check out our article, How to Avoid Probate in Illinois with Revocable Living Trusts.

Revocable living trusts can also allow married couples to take advantage of one another’s estate tax exemptions.  However, unlike many irrevocable trusts, transfer of assets to a revocable living trust does not remove the asset from the grantor’s estate for estate tax purposes.  For more on this check out, Can a Living Trust Avoid Estate Taxes?

Unlike an irrevocable trust, there is no noticeable difference between owning assets in the grantor’s individual name and owning them as trustee of his or her trust as long as the grantor is alive and mentally competent.  This is because the grantor will usually be both the initial trustee and initial beneficiary, meaning that his or her duty as trustee is simply to manage the assets owned by the trust for his or her own benefit in whatever way he or she sees fit.  A revocable living trust is also easily modified or revoked at the grantor’s will.

In sum, a revocable living trust is very much like a will except that it avoids probate, provides the first line of defense against estate tax, and allows the grantor to control how the assets owned by the trust are managed, distributed, and invested for years after his or her death.  There is practically no downside to having a revocable living trust, and the grantor does not have to sacrifice any control over the assets owned by the trust.

What are Irrevocable Trusts Used For?  

Irrevocable trusts are typically used to divide ownership interests in a particular asset or group of assets between multiple people for the purpose of protecting the asset from creditors, planning for long-term care or minimizing estate tax.  

In order for an irrevocable trust to be effective for any of these purposes, the grantor must give up some control over the asset.  Typically, the more control the grantor gives up, the more likely the irrevocable trust will hold up for its intended purpose in the event that it is challenged.  

Using Irrevocable Trusts to Protect Assets From Creditors

When using an irrevocable trust to protect an asset from creditors, the grantor will divide her interest in a particular piece of property between herself and a third party.  Because the property is no longer wholly owned by the grantor, the creditor is not able to foreclose on the property and liquidate it to collect the grantor’s debt.

For example, one way to protect a family home from creditors is for the grantor to transfer the home to an irrevocable trust.  In this scenario, the grantor will typically retain the right to possess the home for the remainder of his or her life, while his or her children have the right to inherit the home after the grantor passes.  

The distinction between this scenario and a revocable trust that leaves the home to the grantor’s children is that when the home is owned by an irrevocable trust the children's’ right to inherit the home has already vested and can no longer be changed by the grantor.  This means that the grantor can’t take the property out of the irrevocable trust or sell the property without the children signing off on the transfer.  The grantor is giving up some part of his or her rights in the property.  

The grantor giving up some of his or her rights in the property is what protects the property from creditors.  Because the property is no longer wholly owned by the grantor, creditors can no longer foreclose on the property.

For more on how irrevocable trusts are used for protection against creditors, check out our article, How to Protect Assets from Creditors.   

How Are Irrevocable Trusts Used in Long-Term Care Planning?

The same strategy can be used in planning for long-term care.  Because long-term care is very expensive, many people rely on Medicaid to pay for long-term care expenses.  However, Medicaid requires that the person applying for Medicaid “spend down” their own assets before they will be eligible for Medicaid benefits.

Individuals anticipating long-term care can use an irrevocable trust to retain a lifetime right to possess their home while transferring the right to inherit the property to their children.  This removes the home as an asset for the purposes of Medicaid while still allowing them to pass it to their children rather than have the home liquidated to pay back Medicaid after they pass.  

Note that, in order to be effective, long-term care planning must typically be done

For more on how irrevocable trusts are used for long-term care planning, check out  our article, Illinois Medicaid Planning Explained.

How Are Irrevocable Trusts Used in Estate Tax Planning?

Irrevocable trusts are also used to remove assets from the grantor’s taxable estate for estate tax purposes.  As discussed above, revocable living trusts can allow married couples to take advantage of one another’s estate tax exemption, but do not actually remove assets from the taxable estate.  If a married couple’s combined assets are still nearing the Illinois estate tax exemption after we have allowed them to take advantage of each other’s exemptions via a revocable living trust, we will then turn to irrevocable trusts to begin removing assets from the couple’s taxable estate.  The type of trust we use and the strategy we employ is specifically tailored to the client’s particular situation.  

Irrevocable Life Insurance Trusts are used to remove the death benefit of the grantor’s life insurance policy from his or her taxable estate by removing the grantor’s right to change the beneficiaries of the policy.  

Grantor Retained Annuity Trusts, Grantor Retained Income Trusts, and Grantor Retained Unitrusts (GRITs, GRATs and GRUTs), are used to allow an asset such as a business or real estate to appreciate in value without the appreciation in value being considered part of the grantor’s estate.

For much more on estate tax planning strategies check out our article, How to Avoid Estate Tax.  

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Revocable Trusts vs. Irrevocable Trusts | What is the Difference Between a Revocable Trust and an Irrevocable Trust?
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What are Revocable Living Trusts Used For?What are Irrevocable Trusts Used For?Using Irrevocable Trusts to Protect Assets From CreditorsHow Are Irrevocable Trusts Used in Long-Term Care Planning?How Are Irrevocable Trusts Used in Estate Tax Planning?what is the difference between revocable trust and irrevicable trust?

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