Revocable and Irrevocable Trusts

What Are the Differences Between Revocable and Irrevocable Trusts?

Trusts are a legal relationship between one or more persons where assets are held for the future benefit of its recipient.¹ There are a multitude of different types of trusts; here we focus on two broad categories: revocable and irrevocable trusts. To help understand these broad categories, let’s first explore the parties that are involved in them.

Who Are the Different Parties Involved in a Trust?

The key parties in a trust are the grantor, trustee, and beneficiary; the following information about these parties was taken from the IRS.gov. The grantor(s) (also called the settlor, trustor, or creator) generally creates the trust and contributes the assets that the trust will hold. The grantor also establishes the terms or rules that the other parties in the trust must follow. These terms will normally include distribution provisions, the ability to modify the agreement, designation of key parties involved, and under which state the terms of the trust will be governed. The next key person is the trustee(s), also known as the fiduciary. Trustees obtain legal title to the assets within the trust and must follow the ordinances put in place by the grantor. The trustee is responsible for overseeing the trust for the ultimate benefit of the trust’s recipient. Lastly, the beneficiary (or beneficiaries) is the person who will receive the assets held within the trust based on the terms of the trust.

The Differences Between a Revocable and Irrevocable Trust

The most important distinction between a revocable and irrevocable trust is the ability to alter the terms of the trusts once it has been created. With a revocable trust, the grantor can modify or fully revoke the trust after it has been established. This is in stark contrast to irrevocable trusts which cannot be altered once they’ve been put in place.

The second difference is the party who has control and therefore pays taxes on the assets held within the trust. In a revocable trust the grantor retains control over the terms of the trust and its assets, and as a result the grantor must pay taxes on the realized gains of the trust’s holdings. Irrevocable trusts are a separate legal entity where the grantor has relinquished all control over the assets held within it. This means that the trust itself must pay taxes on its underlying assets.

Protection of trust assets is the last major difference between a revocable and irrevocable trust. In a revocable trust, the assets held within the trust are controlled by the grantor and because of this they are not protected from creditors. This means that the assets within the trust could be used as collateral if creditors have a claim on a grantor’s assets. Irrevocable trusts on the other hand provide a layer of protection for that scenario. An irrevocable trust’s assets are no longer under the control of the grantor, meaning creditors cannot lay claim to any of the assets within the trust.^3,4,5

What Happens When the Grantor of a Revocable Trust Passes Away?

When the grantor of a revocable trust passes away, their power to revoke or change the terms of the trust lapses and the status of the trust changes from revocable to irrevocable. An important exception is if the applicable law allows the grantor to revoke the trust by their will.³ This is a relatively uncommon exception; under most circumstances a revocable trust transitions to irrevocable at the time of the grantor’s death. The newly irrevocable trust now needs its own tax identification number and no assets held within the trust can be revoked nor can new assets be added.

A type of irrevocable trust called a testamentary trust does not become operative until the grantor’s death.³ The terms of these trusts are specified in a person’s will and can earmark specific assets of the grantor’s estate to beneficiaries. Unlike other irrevocable trusts, testamentary trusts can be altered by the grantor by changing their will because the trust does not exist until the grantor’s death. Once the grantor passes away the trust becomes irrevocable and cannot be altered unless the trust specifically allows a trustee to revoke the trust or amend its terms.⁶

Managing Revocable and Irrevocable Trusts

One Day In July manages investment assets for both revocable and irrevocable trusts through an ongoing relationship with the trustee(s). Whether the trust is revocable or irrevocable, we use low-cost index funds to both maximize performance and reduce the tax burden on the end client. To avoid the role of custody over client assets, One Day In July prohibits staff and advisors from being designated as Power of Attorney (POA), or trustee of any client trusts.

1. “Definition of a Trust” IRS.gov, accessed April 25, 2023
2. “Abusive Trust and Tax Evasion Schemes - Questions and Answers” IRS.gov, accessed April 25, 2023
3. Ward L. Thomas and Leonard J. Henzke, Jr. “Trusts: Common Law and IRC 501(c)(3) and 4947” IRS.gov, accessed April 25, 2023
4. “4 Differences Between Revocable vs. Irrevocable Trusts” racinelaw.net, accessed April 25, 2023
5. “A Short Primer on Trusts and Trust Taxation” specialneedsalliance.org, accessed April 25, 2023
6. "Testamentary Trusts" nyvbar.org, accessed May 8, 2023