Revocable vs Irrevocable Trust: Key Differences Explained

Wealthy individuals often create trusts to simplify the asset management procedures. A trust is an efficient financial instrument that brings many advantages. Trusts are used for asset protection and tax optimization. Below we discuss the difference between a revocable trust and an irrevocable trust. 

Key facts about trusts in brief

A trust is a fiduciary agreement that the Settlor makes with the Trustee. The former entrusts the latter to keep and manage his/ her assets. Inheritance trusts in particular are highly popular. They allow handing down your property to next generations in a simple and tax-free manner.   

A trust also has a third party, namely, the beneficiary or beneficiaries. These are the people in whose interest the property is managed and who benefits from it. The trust Settlor can simultaneously be a trust beneficiary or even the only beneficiary of the trust. Here we discuss the distribution of power in a trust.

A Trust Deed sets the principles of property management and the principles of profit distribution. Thus, even though the trust Settlor alienates their property from themselves, they lay down the rules anyway.

Trusts can be divided into different types by different criteria. 

• A living trust is created while the Settlor is still alive. A testamentary trust is created after the property owner dies. In this way, the inheritance process is simplified.
• If a trust is non-discretionary, the Trustee has limited powers in profit distribution. The Settlor determines how the profits are going to be distributed to the beneficiaries and the conditions are put on paper. If it is a discretionary trust, the Trustee can distribute the profits at his/ her discretion. He decides how much profit each beneficiary is going to get and when it is going to happen. Whether the trust is discretionary or not, it is an efficient instrument of family capital management. 
• If a trust is revocable, the Settlor is entitled to change the articles of the fiduciary agreement if he/ she wishes to. The Settlor can take the property back, add new items to the list of assets in trust, change the list of trust beneficiaries, and so on. If a trust is irrevocable, the terms of the fiduciary agreement cannot be changed without consent of the trust beneficiaries. In some cases, the terms cannot be changed even with their consent.   

A revocable trust may look more attractive at first sight because the property owner has much more power. However, it has a serious disadvantage that we point out below after discussing the advantages of a revocable trust. 

Advantages of a revocable trust

The most obvious advantage of a revocable trust is the fact that the Settlor still holds the reins even though the property is put in a trust: they decide how the property is to be managed and how the profit is to be distributed. However, a revocable trust has several additional advantages too: 

• Simple inheritance. When the trust Settlor dies, their heirs are going to have little trouble inheriting their property. A probate is required in case the property is inherited via a Last Will and it is not required if the property is kept in a trust. Besides, inheritance taxes are very high in some countries while no taxes are payable if the property is inherited via a trust.
• Confidentiality of asset ownership. If you make a Will, you have to spell out what property is to be handed down to your children. Therefore, everyone will know what property they have inherited. If you create a trust, the information about the assets will remain confidential. 
• Property can be withdrawn from the trust. With a revocable trust, you can withdraw the property from there in case you find yourself in a difficult financial situation, for example. You can even dissolve the trust, that is, cancel the fiduciary agreement. This opportunity, however, deprives you of an important advantage that we discuss below.

Disadvantages of a revocable trust

Even though the Settlor retains control over the property if the trust is revocable, some disadvantages are associated with this type of trust:

• It is a weak asset protection instrument. With a revocable trust, the Settlor remains the property owner from the legal point of view. This means that the property is going to be under threat if a creditor sues the Settlor. It can be confiscated on a court decision, which is not the case with an irrevocable trust (see below). A revocable trust is a good inheritance-planning instrument but it is not a good instrument of asset protection. 
• Heavier tax burden. Because the property in trust remains in the Settlor’s possession, they have to pay taxes on that property. The taxes are smaller than the inheritance taxes would be but they are larger than the taxes payable on the property kept in an irrevocable trust.
• Risk of fraud. The very fact that the terms of the fiduciary agreement can be changed gives certain opportunities to fraudsters. They might try to change the terms without the Settlor knowing about it. 

Advantages of an irrevocable trust

With an irrevocable trust, the Settlor cannot withdraw property from there nor add any new property to the trust. They also cannot change the list of trust beneficiaries and the portions of profits due to them. Moreover, they cannot directly affect the processes of property management. The Trust Deed may allow the Settlor to be involved with the trust’s business if all the beneficiaries consent. The main purpose that an irrevocable trust can serve are as follows:  

• Asset protection;
• Life insurance; 
• Charity.

An irrevocable trust is a preferable instrument of asset protection for a simple reason: legally, the property kept in an irrevocable trust does not belong to the Settlor – it belongs to the trust. Consequently, if the Settlor makes debts, the property in trust cannot be sold to pay them back. It is only reasonable: how could I sell somebody else’s property to pay back my debts?

Irrevocable trusts boast the following main advantages:

• Reliable asset protection. The trust Settlor surrenders their ownership right when putting property in an irrevocable trust. For this reason, creditors cannot claim the property and courts of law cannot rule that the property be expropriated. Theoretically, you could put all your property in trust and declare personal bankruptcy. In some cases, it may be the only way out of a difficult situation.
• Lesser tax burden. Because the property is separated from the trust Settlor, he or she does not have to pay taxes on it. Beneficiaries are taxed on the financial benefits that they receive from the trust but the property in trust is not taxed.
• Confidentiality. Irrevocable trusts provide a high level of financial confidentiality. When the property is in trust, the Settlor does not have to declare it because it is not his/ her property. 

Disadvantages of an irrevocable trust

Detachment of the property from its owner is more of a psychological disadvantage. At the same time, you would have to put up with two disadvantages that are more material if you create an irrevocable trust:

• Insufficient flexibility. The trust settlor surrenders control over the property and now it is under the control of the Trustee. However, the Settlor can be a beneficiary of the trust too, which means that he or she can continue to benefit from the property in trust.
• Complex legal structure. A trust is a complicated financial instrument. You certainly need to involve professionals in the process of trust formation. Trust management is also a challenging task and finding a reliable and highly-qualified trustee is important.

Revocable or irrevocable trust?

The choice of the trust type will depend on your primary goal. Would you like to hand down the property to your heirs sparing them the need to wait and pay taxes? If so, a revocable trust should be your choice.

Would you like to protect your assets from possible claims, enhance the confidentiality of your personal information, and save on taxes? In this case, you should create an irrevocable trust.

We would like to note in conclusion that an offshore trust would serve as the most efficient instrument of asset protection and tax optimization. Our experts will gladly help you form an offshore trust and provide support to you at every stage of the process.