“Can I use a revocable trust for that instead of an irrevocable trust?” I get that question a lot from clients. Whether you need a revocable or an irrevocable trust depends on what you are trying to accomplish with the trust.
A trust is a fiduciary relationship through which one person, called the trustee, holds assets for the benefit of another person, called the beneficiary. A trust is actually the relationship of the trustee to the beneficiary, a relationship of trust. The beneficiary trusts the trustee to abide by the terms of the trust agreement. The beneficiary trusts the trustee to perform his obligations—the obligation of confidentiality, of loyalty, of prudence—for the benefit of the beneficiary.
The trust instrument is the agreement that establishes the terms of the trust. The terms of the trust tell the trustee how to make distributions of principal and income from the trust to the beneficiary. The terms of the trust may tell the trustee why the grantor established the trust for the benefit of the beneficiary.
The grantor of the trust is the person who had the trust instrument drafted, typically by an attorney. The grantor is also the person who funds the trust with his/her assets.
I can put all of these concepts together in a hypothetical example. Mr. Smith wants to establish a trust for his son, Joe. Joe has issues with alcoholism and spending money frivolously. Joe has a number of creditors to whom he owes money. Mr. Smith does not want to leave any of his money to Joe because he fears that Joe will spend the money on alcohol or that Joe’s creditors will get Mr. Smith’s money.
Mr. Smith goes to his attorney. Mr. Smith’s attorney drafts a trust for Mr. Smith. The trust instrument names Mr. Smith as the initial trustee. If Mr. Smith is incapable of serving as the trustee, the attorney drafts the trust instrument so that Joe’s sister, Mary, will serve as successor trustee, the successor to Mr. Smith.
Mr. Smith places some of his money in this trust. When Mr. Smith dies, more of his money will pass to the trust.
The trust instrument states that the trustee can distribute income and principal to Joe at the trustee’s sole and absolute discretion. The terms of the trust state that the trustee has no obligation to make a distribution to Joe other than at the trustee’s sole and absolute discretion.
A trust such as this one may be revocable during Mr. Smith’s life but become irrevocable after his death. A revocable trust is a trust the terms of which can be modified or revoked. When the trust is revocable, Mr. Smith could simply cancel the trust and obtain a return of all of the money that he placed in the trust.
An irrevocable trust is a trust the terms of which cannot be modified or revoked. After Mr. Smith’s death, Mr. Smith would want the trust that he established for his son, Joe, to be irrevocable. In this way, Joe could benefit from the money in the trust and his creditors could never get at the money in the trust. Mary, as the trustee, would have sole discretion to distribute the money to Joe as she deemed fit and proper.
There are a number of circumstances in which a person may want to use a revocable or an irrevocable trust. In the example above, while Mr. Smith is alive and is primarily planning for Joe’s well-being after Mr. Smith’s death, Mr. Smith would use a revocable trust instrument because he may want to change the terms of the trust if circumstances change before he dies.
A person may use an irrevocable trust if he were planning for potential Medicaid eligibility or engaging in tax planning. For instance, when planning for Medicaid eligibility using a trust, the trust instrument has to be irrevocable in order for the trust to effectively shelter the assets of the client from Medicaid eligibility. If the client could simply revoke the trust and obtain a return of the assets he placed in the trust, then those assets are still available to him for purposes of determining his eligibility for Medicaid.