Revocable Trust Vs. Irrevocable Trust

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1 I am not an attorney but here to help you undertand what things are... Speak to An Asset protection Attorney and find the best solution for you... Revocable Trust Vs. Irrevocable Trust Trusts are relatively common but not particularly well understood. Though there are numerous special types of trusts, most fall into the two general categories of revocable or irrevocable. Revocable trusts are by far the most common. Living trust also called inter vivos trusts, are examples of revocable trusts. An inter vivos trust passes assets after death but, unlike a will, is in force during the grantor's lifetime and allows him to retain control. These instruments are used to keep assets out of probate while allowing you to keep control of them during your lifetime. Irrevocable trusts are also part of estate planning, but they have more specific and particularized applications. Revocable Trust As the name suggests, a revocable trust is one that the creator of the trust, called the grantor, can alter or cancel at any point. Revocable trusts are the most common form of trusts, used most often to transfer assets after death without going through probate. Usually, the grantor names himself as trustee of the trust, thus retaining control over the assets during his lifetime. When she dies, a named successor trustee takes over and transfers the assets to heirs. Irrevocable Trust An irrevocable trust, by contrast, is a permanent transfer of assets from the grantor to the trust. An irrevocable trust can actually be altered, amended or terminated by agreement of at least the grantor and the trustee (and usually also the beneficiaries), but not by unilateral action by the grantor. Irrevocable trusts are sometimes used to secure transactions. They can also be part of an estate plan, particularly for the transfer of life insurance proceeds, since the grantor has no interest in these during his lifetime anyway. Income Tax

2 The Internal Revenue Service (IRS) treats revocable trusts as a pass-through entity, calling them grantor trusts. The income or capital gains of a grantor trust are taxed individually to the grantor. An irrevocable trust, though irrevocable under the state law under which it is formed, can still be treated as a grantor trust by the IRS if the grantor retains control, interest or benefit in the assets of the trust or the ability to allocate them among beneficiaries. Sections 2306 to 2308 of the Internal Revenue Code describe the requirements for an irrevocable trust to avoid treatment as a grantor trust. Estate Tax Similarly, the IRS treats property held in a grantor trust as part of a decedent's gross estate for estate tax purposes even though it doesn't go through probate. This is especially important if the proceeds of the trust are enough to surpass the exemption and trigger the tax. In order for the property of an irrevocable trust to not be included in the gross estate it must have been transferred to the trust more than three years before the death of the grantor, and the trust itself must meet the substantial interest requirements of sections 2306 of 2308 of the Internal Revenue Code. Gift Tax As many wealthy individuals are aware, it's possible to reduce one's taxable gross estate by bestowing gifts. An annual exclusion ($12,000 in 2007) limits the value of a gift to a single recipient that can be given without triggering a gift tax. Gifts in excess of the annual exclusion count toward the gross estate after death. Assets gifted to a trust are exempt from the gift tax up to the amount of the annul exclusion multiplied by the number of beneficiaries in the trust. However, as mentioned, the proceeds of revocable trusts and some irrevocable trusts are pulled back into the gross estate at death. MORE: Revocable Living Trust A Revocable Living Trust, also called a Revocable Trust, Living Trust or Inter Vivos Trust, is simply a type of trust that can be changed at any time. In other words, if you have second thoughts about a provision in the trust or change your mind about who should be a trust beneficiary or trustee, then you can modify the terms of the trust through what is called a trust amendment. Or, if you decide that you do not like anything about the trust at all, then you can either revoke the entire agreement or change the entire contents through a trust amendment and restatement. Since Revocable Living Trusts are so flexible, why aren t all trusts revocable? Because the down side to a revocable trust is that assets funded into the trust will still be

3 considered your own personal assets for creditor and estate tax purposes. This means that a revocable trust offers no creditor protection if you are sued, all of the trust assets will be considered yours for Medicaid planning purposes, and all assets held in the name of the trust at the time of your death will be subject to both state and federal estate taxes and state inheritance taxes. So why should you use a Revocable Living Trust as part of your estate plan? For three important reasons: 1. To plan for mental disability - Assets held in the name of a Revocable living Trust at the time a person becomes mentally incapacitated can be managed by their Disability Trustee instead of by a court-supervised guardian or conservator. 2. To avoid probate - Assets held in the name of a Revocable Living Trust at the time of a person s death will pass directly to the beneficiaries named in the trust agreement and outside of the probate process. 3. To protect teh privacy of your property and beneficiaries after you die - By avoiding probate with a Revocable Living Trust, your trust agreement will remain a private document and avoid becoming a public record for all the world to see and read. This will keep the details about your assets and who you have decided to leave your estate to a private family matter. Contrast this with a Last Will and Testament that has been admitted to probate - it becomes a public court record that anyone can see and read. Irrevocable Trusts An irrevocable trust is simply a type of trust that cannot be changed after the agreement has been signed, or a revocable trust that by its design becomes irrevocable after the Trust-maker dies. With the typical Revocable Living Trust, it will become irrevocable when the Trustmaker dies and can be designed to break into separate irrevocable trusts for the benefit of a surviving spouse, such as with the use of AB Trusts or ABC Trusts, or into multiple irrevocable lifetime trusts for the benefit of children or other beneficiaries. Irrevocable trusts can take on many forms and be used to accomplish a variety of estate planning goals: Estate Tax Reduction

4 Irrevocable trusts, such as Irrevocable Life Insurance Trust, are commonly used to remove the value of property from a person s estate so that the property cannot be taxed when the person dies. In other words, the person who transfers assets into an irrevocable trust is giving over those assets to the trustee and beneficiaries of the trust so that the person no longer owns the assets. Thus, if the person no longer owns the assets, then they cannot be taxed when the person later dies. As mentioned above, AB Trust that are created for the benefit of a surviving spouse are irrevocable and, thus, can make full use of the deceased spouse's exemption from estate taxes through the funding of the B Trust with property valued at or below the estate tax exemption. Then, if the value of the deceased spouse's estate exceeds the estate tax exemption, the A Trust will be funded for the benefit of the surviving spouse and payment of estate taxes will be deferred until after the surviving spouse dies. ABC Trust can be used by married couples who live in a state that collects a state estate tax and the state estate tax exemption is less than the federal estate tax exemption. For example, in Massachusetts the state estate tax exemption is only $1 million, as compared with the current federal $5.12 million exemption, so in Massachusetts the first $1 million will go into the B Trust, then next $4.12 million will go into the C Trust, and anything over $5.12 million will go into the A Trust. Asset Protection Another common use for an irrevocable trust is to provide asset protection for the Trust-maker and the Trust-maker's family. This works in the same way that an irrevocable trust can be used to reduce estate taxes - by placing assets into an irrevocable trust, the Trust-maker is giving up complete control over, and access to, the trust assets and, therefore, the trust assets cannot be reached by a creditor of the Trust-maker or an available resource for Medicaid planning. However, the Trust-maker's family can be the beneficiaries of the irrevocable trust, thereby still providing the family with financial support, but outside of the reach of creditors. There are also irrevocable trusts called Self-Settled Trusts or Domestic Asset Protection Trusts that in some states, including Alaska, Delaware, Nevada, and Tennessee, offer creditor protection and allow the Trust-maker to be a trust beneficiary. In addition, as mentioned above, the various irrevocable trusts that can be created for the benefit of the Trust-maker's surviving spouse or other beneficiaries after the Trust-maker of a Revocable Living Trust dies can be designed to offer asset protection for the trust beneficiaries. Charitable Estate Planning Another common use of an irrevocable trust is to accomplish charitable estate planning, such as through a Charitable Reminder Trust or a Charitable Lead Trust. If the Trust-maker makes the initial transfer of assets into a charitable trust while

5 still alive, then the Trust-maker will receive a charitable income tax deduction in the year of the transfer is made. Or, if the initial transfer of assets into a charitable trust doesn't occur until after the Trust-maker's death, then the Trust-maker s estate will receive a charitable estate tax deduction. AB TRUST: When planning to reduce federal estate taxes, married couples can make use of the AB Trust system to effectively transfer two times the federal estate tax exemption to their heirs free from federal estate taxes. But in most states that collect their own separate estate tax, traditional AB Trust planning can cause part of the B Trust to be taxed when the first spouse dies. Enter the ABC Trust system of estate planning for married couples, also known as "gap trust planning" and making the "state QTIP election," which in a handful of states allows payment of both federal and state estate taxes to be deferred until after the surviving spouse's death. So how does ABC Trust planning work? Understanding Traditional AB Trust Planning In order to understand how the ABC Trust system works, you'll first need to understand how the AB Trust system works. If a married couple has an AB Trust estate plan, then when the first spouse dies an amount equal to the federal estate tax exemption will be funded into the B Trust and anything over this amount will be funded into the A Trust. What does this do? It uses up the deceased spouse's federal estate tax exemption so that when the surviving spouse later dies, what's left in the B Trust won't be taxed in the surviving spouse's estate. The surviving spouse will then be able to leave an amount equal to their own federal estate tax exemption to children or other beneficiaries, thereby allowing married couples to pass on two times the federal estate tax exemption free from estate taxes. But what happens to the assets left in the A Trust? While these assets will be taxed as part of the surviving spouse's estate, payment of the tax will be deferred until after the surviving spouse dies. Here's an example: Joe and Mary are worth $12 million, and when Joe dies in 2013 he has $6.25 million in his separate name or Revocable Living Trust and his estate plan includes AB Trust planning. Under these facts, $5.25 million will go into Joe's B Trust and $1 million will go into Joe's A Trust, both for Mary's benefit, and no federal estate tax will be due as a result of Joe's death. Instead, when Mary later dies the B Trust won't be taxed since it used up Joe's estate tax exemption and only what's left in the A Trust will be taxed as part of Mary's estate.

6 ABC TRUST: Enter the State Death Tax Gap and Use of ABC Trust Planning Using the same facts above, what would happen if Joe and Mary lived in Tennessee, which collects a separate state estate tax in addition to the federal estate tax and only offers a $1.25 million state exemption in 2013? Upon Joe's death $5.25 million should go into the B Trust and $1 million should go into the A Trust, but because the amount being funded into the B Trust greatly exceeds the $1.25 million Tennessee estate tax exemption, there will be a Tennessee estate tax bill of about $498,750 after Joe's death. Thus, $5.25 million will go into the B Trust and only $501,250 will go into the A Trust. If, however, Joe and Mary's estate plan is drafted to take advantage of the ABC Trust system, then instead Joe's estate will be divided up as follows: $1.25 million will go into the B Trust - exempt for state and federal purposes $4 million will go into the C Trust - state QTIP only, exempt for federal purposes $1 million will go into the A Trust - state and federal QTIP Thus, the ABC Trust plan will thus result in no Tennessee or federal estate taxes being due at the time of Joe's death. What Does the C Trust in ABC Trust Planning Do? As illustrated above, the B Trust will hold the Tennessee state estate tax exemption of $1 million, the C Trust will hold the difference between the Tennessee estate tax exemption and federal estate tax exemption of $4 million, and the A Trust will hold what's left. Thus, the C Trust effectively defers the payment of both Tennessee and federal estate taxes on the gap of $4 million between the Tennessee and federal estate taxes until after the surviving spouse dies, but still preserves the entire $5.25 million federal estate tax exemption for the next generation. Speak to An Asset protection Attorney and find the best solution for you...