Investor Alert

Outside the Box

Oct. 20, 2021, 12:04 p.m. EDT

What’s the difference between a revocable and irrevocable trust?

Watchlist Relevance

Want to see how this story relates to your watchlist?

Just add items to create a watchlist now:

or Cancel Already have a watchlist? Log In

Harry Margolis

On the surface, the difference between revocable and irrevocable trusts couldn’t be any more straightforward. You can change your revocable trust whenever and however you choose. You can’t change your irrevocable trust at all.

But beneath the surface, the waters are a bit more murky, especially with respect to making changes. Also, revocable trusts often become irrevocable when the grantor becomes disabled or passes away. So, let’s jump into these waters and clear up some of the murk.

The ability to amend

It is true that the grantor of a revocable trust (sometimes called a “living” trust) can change it as she chooses, as long as she’s competent. If she becomes incompetent she can’t change it, though her agent under a durable power of attorney or a court-appointed conservator may be able to do so.

Irrevocable trusts are a different story, but they’re not completely barred from being changed. Let’s start by distinguishing between trusts that are irrevocable upon their creation, such as those created for asset protection, tax planning or Medicaid planning purposes, and trusts that become irrevocable upon the grantor’s death.

Grantors when creating immediately irrevocable trusts often still retain certain powers such as the right to change trustees and the right to redirect who will receive the trust property when they die or when the trust terminates at another time. The latter is known as a “testamentary power of appointment.” It can be broad or “general”, permitting the “appointment” of property to anyone, or more limited, for instance only allowing trust property to be redirected to family members and charities.

Whenever the trust becomes irrevocable, the grantor may give these rights — the power to change trustees or to change ultimate beneficiaries — to other parties, often to the beneficiaries themselves. For instance, a trust may say that a majority of the grantor’s children can hire and fire trustees and that each child can say where his share will go in the event he dies before receiving it.

Asset protection and special needs trusts also often appoint “trust protectors” who have the power not only to change trustees but sometimes to amend the trust completely. In such cases, the trust is irrevocable from the point of the grantor — she can’t revoke or amend it — but it’s actually completely amendable by the trust protector. Or the trust might limit this power, for instance in the case of a special needs trust only permitting amendments as necessary for the beneficiary to maintain eligibility for public benefits. This power is often granted to either the trustee or trust protector because public benefits programs often change their rules with respect to the treatment of trusts.

In recent years, irrevocable trusts have become less irrevocable as states, whether by court decision or new statutes, have permitted decanting, reformation and nonjudicial settlements of trusts.

Decanting is similar to the practice of pouring fine old wines into new carafes in order to let them breathe. With trusts, the concept is to transfer trust assets into new trusts that better accomplish the purpose of the initial trust. This practice gained steam when the Massachusetts Supreme Judicial Court permitted the Kraft family of Patriots football fame to decant one trust into a new one that would better achieve their original goals.

Depending on state law, in order to decant, a change in law or circumstance must being impeding the original trust from achieving its intent and all beneficiaries must agree with the change to the new trust, which should not change anyone’s interest in the trust.

Trust reformation, unlike decanting, requires court approval of a change to an irrevocable trust. Like decanting, those seeking such a change must show that the reformation is necessary for the trust to achieve its original purpose. All current and future beneficiaries must be given notice, but they don’t all have to agree.

Thirty-four states and the District of Columbia have adopted the Uniform Trust Code which permits trust reformation without the involvement of a court, known as nonjudicial settlement agreements, where all interested parties are in agreement. The statute permits any change that does not violate a so-called material purpose of the trust. So, in effect, as long as all interested parties are in agreement, any irrevocable trust can in fact be modified.

While the parties can avoid going to court if all can agree to decanting or a nonjudicial settlement agreement, if they’re not on the same page or some parties are noncooperative, which is not unusual, the proponents of a change will have to seek court approval of trust reformation.

Tax treatment

When it comes to taxation of trusts, again, revocable trusts are quite simple and the waters can get deep and treacherous with respect to irrevocable trusts.

Revocable trusts use the grantor’s Social Security number and all income is taxed to the grantor.

Page 1 Page 2
This Story has 0 Comments
Be the first to comment
More News In

Story Conversation

Commenting FAQs »

Partner Center

Link to MarketWatch's Slice.