Maybe one of the most common questions I am asked by clients is about the differences between revocable trusts and irrevocable trusts. I usually begin to answer the question the same way I will here, revocable trusts are designed as a substitute for your Last Will and Testament. If you want protection for your assets from your long-term health care expenses, a revocable trust will not work at all. Let me repeat: revocable trusts DO NOT protect your assets from nursing home and other long-term health care expenses. With that in mind, let's consider both types of trusts and how they work.
Revocable Trusts: The Will Substitute
As mentioned above, a revocable trust is primarily a substitute document for your Last Will and Testament. What does that mean? In New York, if you have a revocable trust that owns, for example, your home and all your bank accounts, your revocable trust dictates to whom those assets will be distributed when you pass away, not your Last Will and Testament.
For example, Daniel Smith has the Daniel Smith Revocable Trust that owns his residence, his bank accounts, and his investment portfolio. Every one of those assets has been re-titled to the "Daniel Smith Revocable Trust". The Daniel Smith Revocable Trust says that when he passes away all of his assets go to his church. Daniel's Last Will and Testament says that when he passes away all of his assets go to his nieces and nephews. So, as things stand, when Daniel passes away, his residence, his bank accounts and his investment portfolio will all be distributed to his church, according to the terms of the Daniel Smith Revocable Trust.
On the other hand, Daniel had some savings bonds and a few Certificates of Deposit at his bank, and none of these were titled to the Daniel Smith Revocable Trust, meaning he owned them all in his name alone. In this situation, Daniel's Last Will and Testament will direct to whom these assets are distributed. Now, if the Will has a clause that directs these assets be distributed to the Daniel Smith Revocable Trust (a so-called "pour-over" clause), this could all end well. However, if Daniel's Will was signed at a different time than his Revocable Trust and does not have a clause directing his assets be distributed according to the terms of the Daniel Smith Revocable Trust, the savings bonds and Certificates of Deposit will be distributed to his nieces and nephews. This could be fine, assuming it is what Daniel Smith intended. In my experience, that is not the case, and that is the pitfall with using trusts in New York. Unless you are diligent and carefully re-title all of your assets either to your Revocable Trust, or using a beneficiary designation, you could have multiple distribution schemes for your assets, which can lead to confusion, increased costs in administering your estate, and your assets not necessarily being distributed as you intended.
The revocable trust can work really well if the primary goal is to avoid probate. To me, avoiding probate is not a big deal. Many lawyers will aggressively market probate avoidance to prospective clients and talk up how much the probate process will cost their estate in legal fees. The bottom line is that with a reputable estate attorney, the costs to probating your Will after you die should not be exorbitant. In any case, the revocable trust only totally avoids probate if you are diligent in re-titling all of your assets. Miss re-titling one asset or open a new account later in just your name, and your Will would have to be probated anyway for that one account.
Here's a quick rundown of the pros and cons of the revocable trust:
Now, let's turn our attention to irrevocable trusts and highlight some of the differences with revocable trusts.
Irrevocable Trusts: Asset Protection and Probate Avoidance
As discussed above, the major difference between revocable trusts and irrevocable trusts in my world is that irrevocable trusts can provide the ability to protect assets from the costs of nursing home, assisted living and other long-term health care expenses. We know that at least 70% of seniors 65 and older will require some sort of long-term health care during their lives (LongTermCare.gov) and that the average cost of this care is growing rapidly, with some nursing homes exceeding $13,000 per month.
With that in mind, long-term health care expenses are now the greatest financial threat seniors will face in retirement. Minimizing the financial outlay to pay for these long-term care expenses is often seen as a desirable outcome by many of my prospective clients. In that respect, using an irrevocable trust, often called a Medicaid Qualifying Trust, gives us the ability to re-title assets (just as with the revocable trust) with the goal of insulating them from long-term health care expenses.
Let's use Daniel Smith's example from above to see how the Medicaid Qualifying Trust works. We have the Daniel Smith Irrevocable Trust and it owns Daniel's residence, bank accounts and investment account. If he has created the Daniel Smith Irrevocable Trust and funded it with these assets 5 years before he requires long-term health care in an assisted living facility or nursing home, these assets will be insulated and not required to be used to pay for these long-term health care expenses. In our example, Daniel's savings bonds and Certificates of Deposit could still be used to pay for his long-term health care costs, because he owns them in his name alone, not in the Daniel Smith Irrevocable Trust.
The Irrevocable Trust works very much like a safe where you are the only person with the combination. You re-title assets to the Trust (place them in the safe), don't touch the principal (locking the safe), and after five years from the time you've put them in the safe, the principal value of those assets is protected from your long-term health care costs.
Here are some pros and cons for the irrevocable trust:
There is much more that can be said about both of these types of trusts. I previously wrote about how many people get swindled into purchasing revocable trusts here. I also wrote about irrevocable trusts and Medicaid here and here. Be sure to check them out and let me know of any questions by email firstname.lastname@example.org