Estate planning is a crucial part of any holistic financial plan. As a financial advisor, you could direct your clients to an estate planning attorney for guidance in this area, but while attorneys are great, and necessary, for crafting the legal documents used in estate planning, they don’t always see the big picture.
An attorney may focus only on how the estate plan will impact your client’s overall estate, without giving due consideration to how the plan will affect your client while she is still alive. It’s important for you, as your client’s advisor, to understand the elements of estate planning so you can guide your client to the best option for her present and her future.
One common element in estate planning is a trust, which comes in two varieties: revocable and irrevocable. The main difference between a revocable trust and irrevocable trust is all in the name: One can be revoked or amended by the trust’s creator (called the grantor), the other can not. With an irrevocable trust, the grantor cannot make changes without the consent of the beneficiaries.
This distinction leads to several benefits and drawbacks for each type of trust. Here’s a look at the pros and cons of a revocable versus irrevocable trust and how you can help your client choose which one to use.
[SUBSCRIBE: Get the weekly U.S. News newsletter for financial advisors. ]
The Benefits and Drawbacks of a Revocable Trust
“The main benefit of a revocable trust is the protection that it provides by ensuring that the grantor’s wishes are implemented if incapacitated,” says Kalimah White, senior trust advisor at TD Wealth Management. “Revocable trusts can also be used to avoid probate whereby the terms of the trust continue without delay of probate or will challenges from beneficiaries.”
But revocable trusts aren’t without their drawbacks, most notably being that there are no tax benefits or creditor protection. The law requires the grantor to “give up” the right to modify a trust to take advantage of most federal and state income tax benefits, including exemptions. Since the grantor of a revocable trust retains this right to modify the trust agreement, the law does not allow the grantor to hop in and out of a trust to reduce taxes or protect assets.
[See: 15 Financial Advisor Marketing Tips]
The Benefits and Drawbacks of an Irrevocable Trust
Since tax benefits are denied to grantors of revocable trusts, the ability to save on taxes through various income or estate and gift planning strategies becomes one of the main benefits of an irrevocable trust, experts say.
“The IRS provides many exemptions to certain tax laws. For example, retaining assets in a trust for generations so they’re never subject to estate tax that require an irrevocable trust to work properly,” White says.
Irrevocable trusts also come with creditor protection. “Assets titled in your own name are subject to creditors, including ex-spouses and taxing authorities,” White says. “Assets titled in the name of an irrevocable trust. In many instances, are protected from the reach of creditors or, at minimum, provide hurdles for the creditor that may prompt settling the claim for pennies on the dollar.”
While saving on taxes and creditor protection can be great benefits for your clients, advisors can’t forget that many people do not enjoy losing control over their assets, White adds. Your clients may not like the idea of “locking up” their funds and only being able to access them at the discretion of a trustee or third party.
“Some clients find it disadvantageous to be a beneficiary of an irrevocable trust and at the mercy of a trustee for access to trust assets, especially in situations where parents or grandparents established the trust,” White says.
That said, she points out that nowadays irrevocable trusts are less irrevocable. “There are several ways to modify a trust to increase the client’s control over the trust assets and a client’s ability to retain a beneficial interest in a trust, while at the same time providing creditor protection and substantial tax savings potentially,” she says.
You can work with an estate attorney to help you increase your client’s control of their trust’s assets.
[Read: Financial Advisor Q&A: The Foundation for Financial Planning.]
Choosing Between a Revocable vs. Irrevocable Trust
Given that there are benefits and drawbacks to both, it can be hard to know which type of trust is right for your client. Expert advice: Start by determining your client’s goals.
“If the client’s main goal is to plan for incapacity, they may only need a revocable trust, which always should include a pour-over will, financial power of attorney and health care directive and proxy to complete the estate planning package,” she says. “Alternatively, if the main goal is creditor protection and/or tax savings, a client can only accomplish such goals with an irrevocable trust.”
More from U.S. News
10 Questions to Ask Financial Advisors
What Questions Should Investors Ask Financial Advisors Now?
Should an Advisor Ever Fire a Client?
Choosing Between a Revocable and Irrevocable Trust for Your Client originally appeared on usnews.com
