Revocable Trusts
When comparing revocable vs. irrevocable trusts it’s important to understand their foundations. There are two types of Revocable Trusts: an individual Revocable Trust and a “Joint” Revocable Trust. Each of them owns the property as if the Grantor or Grantors still owned it. They both use the Grantor’s social security number as it’s tax identification number. Therefore, the Grantor reports all income owned by it on their 1040. Additionally, the Grantor can revoke, change, or amend the Trust at any time. This means that full control of the assets still remains with them. There are many benefits that a Revocable Trust presents for the Grantor and their beneficiaries. A few of the major ones are listed below:
Probate Avoidance
What is the difference in probate avoidance with revocable vs. irrevocable trusts? Typically, either entity will provide for probate avoidance upon the death of the grantor.
Any asset owned by an individual freezes upon their death, requiring probate before anyone can access it. This is true regardless of whether the decedent had a validly executed Last Will & Testament.
The Probate Process
You must wait 30 days from the decedent’s date of death before you can file a probate petition. Then, a magistrate or judge must review the petition. This typically takes 6-8 weeks but can be as long as 3-4 months depending on the backlog of the court. Furthermore, the filing fees associated with probate will be approx. $750-$1,000 to open it, not including the attorney’s fees. The petitioner must incur these fees “out of pocket” until the probate is approved.
The retitling process begins once the petition has been approved by the court. This requires presenting the paperwork to each financial institution to have title to the asset changed to the estate. The estate must have its own tax identification number and must file annual income tax returns. This poses a problem for investment account owners because trades cannot be made until the title is changed. Then must pay estate tax rates on the income generated therein. The top estate tax bracket is approx. $13,000 of AGI and is taxed at 39%.
Real Estate in Probate
Next, if the estate owns any real estate, they must petition the Court for a license to sell. After accepting an Offer to Purchase the property, one can only apply for this license. This typically prolongs the real estate deal’s closing time.
Finally, the creditor claim period requires to assets be held in the estate for one year. Meaning heirs of an estate will not receive their inheritance until one year has passed from the decedent’s death.
A fully funded Revocable Trust avoids all of the above.
Asset Protection
Is there any difference between asset protection with a revocable vs. an irrevocable trust? Yes, an irrevocable trust will typically provide asset protection for the grantors. Whereas a revocable trust cannot, but it can provide asset protection for your heirs.
A Revocable Trust can offer asset protection for heirs which would not otherwise be available. This can include a standby Supplemental Needs Trust in case the inheritance would disqualify the beneficiary from government benefits. It can also include individual shares for each beneficiary. These allow their inheritance to be protected from creditors, bankruptcy, liens, and spouses in the case of divorce.
Marital Tax Planning
What marital tax planning options are there between a revocable vs. irrevocable trust? An Irrevocable trust can provide numerous different types and levels of tax planning for wealthy clients. However, a revocable trust can also provide tax planning for married couples.
Massachusetts levies an estate tax against any estate with a combined net worth more than the currently set exemption. While the assets in an irrevocable trust will not be taxed, they will still be counted towards the exemption. Indeed, transfers to an irrevocable trust will be a taxable gift which is countable towards the exemption amount.
Conversely, without any trust, when the first spouse dies, all of their assets pass to the surviving spouse. However, the first spouse to die’s exemption does not transfer over to the surviving spouse with those assets. Therefore, the surviving spouse is left with only their exemption but all the assets. A Revocable Trust can preserve the first spouse to exemption by using a Credit Shelter Trust. This effectively doubles the married couple’s estate tax exemption and saves up to $200,000 in Massachusetts Estate Taxes.
Additionally, for capital gains tax, joint property receives a 50% step up in cost basis at the first spouse’s death. Then another 50% step up in cost basis at the second spouse’s death. In the case of a Joint Revocable Trust, the property receives a 100% step up in cost basis at the first spouse’s death and the second spouse’s death. This can be especially helpful when the surviving spouse wishes to “downsize” by selling the family home.
Guardian/Conservatorship for Minor Children
Is there any difference between a revocable vs. irrevocable trust if I have minor children? If something were to happen to you before one or both of your children reached the age of majority (18), both a Revocable Trust and Irrevocable Trust would allow you to nominate a Guardian and Conservator without anyone having to petition a Court. The Guardian would be the caregiver and provider of the children, while the Conservator/Trustee would be the individual with control over the assets for the children’s benefit. You would be able to customize the Trust to include any provisions/stipulations/conditions which you want to place on the Guardianship or Conservatorship. This allows for much more flexibility, as well as avoiding Court filing fees and oversight.
Irrevocable Trusts
Medicaid (Masshealth) Irrevocable Trusts
Irrevocable Trusts impose more administrative hurdles and downsides compared to Revocable Trusts. They offer the benefit that assets within the Irrevocable Trust are exempt from Medicaid payback provisions only if transferred at least 5 years before Medicaid application. The Grantor cannot amend or change Irrevocable Trusts once created. They also lose ownership of the principal within the Trust and cannot touch it. Furthermore, the Grantors are entitled to monthly payments from the Trust only until they qualify for Medicaid.
Therefore, I typically only advise clients to create a Medicaid planning trust in limited scenarios. For example, if a client is at a high risk for a long-term disease, such as Alzheimer’s, MS, or Dementia. Additionally, a Medicaid trust precludes a client from assisted living or other pre-nursing home care. That means they are destined for a nursing home that accepts Masshealth the moment they can no longer be cared for in their home.
The most common scenario is when the grantor’s only asset is a family home which they want to protect from Medicaid’s payback provision. Otherwise, the drawbacks of the Irrevocable Trust tend to outweigh the potential benefits, as the Irrevocable Trust is only useful if the grantor’s end up needing long term nursing home care through Medicaid.
Irrevocable Life Insurance Trusts (ILITS)
Irrevocable Life Insurance Trusts (ILITs) are valuable estate planning tools designed to protect life insurance proceeds from estate taxes. Moreover, they can be a useful tool for individuals who have large retirement accounts that they wish to shield from estate taxes. By establishing an ILIT, individuals can remove life insurance policies from their taxable estate, ensuring that beneficiaries receive the full benefit without estate tax implications. These trusts become irrevocable once established, meaning they cannot be altered or revoked, providing certainty and protection for the insured’s loved ones. Additionally, ILITs offer flexibility in distributing assets and allow for structuring to meet specific needs and objectives within an estate plan.
