Irrevocable Trusts – a Valuable Tool in Medicaid Planning
An irrevocable trust sounds like obscure lawyerly jargon. In reality, it’s a concept that can be easily understood by the layman. It’s worth taking the time to learn about it and the many benefits it offers, both as a tool for planning and a structure that protects you and your hard earned assets. Let’s start by defining the basic term of “a trust”.
What is an Irrevocable Trust?
A trust is a contract between the grantor – the person who creates the trust, the trustee, who controls the trust, and the beneficiaries. You, as grantor, determine how the trust will be operated by the trustee and who benefits, how and when. While a revocable trust permits you to maintain full control (as trustee) and have access to all your assets (as beneficiary), an irrevocable trust may prohibit your right to control the trust (as trustee) or have access to your assets, but you decide to what extent.
Is an Irrevocable Trust Carved in Stone?
Mr. Silver is a 60-year-old entrepreneur who is accustomed to having full control over his assets. He’s generous to his children, who are now all adults, but isn’t convinced they always make prudent decisions. He’s also skeptical about trusts, having the impression that they’re a cash grab on the part of financial institutions. His bank manager tells him that he can provide the necessary documents for free if he wants to gift his assets outright to his children. The other costs involved in outright gifting, including preparing and filing deeds and a gift tax return, seem to be minimal.
Mr. Silver’s golfing partner suggests he consult an elder law attorney with estate planning experience. Mr. Silver is worried that his carefully accumulated assets will get swallowed up by medical expenses if he becomes ill so he reluctantly agrees. The attorney recommends that he establish an irrevocable trust to plan for Medicaid eligibility but Mr. Silver balks, imagining a rigid and unchangeable arrangement.
Why Use an Irrevocable Trust?
The attorney points out that when implementing Medicaid asset protection planning, the rules are less restrictive:
• You’re able to choose or remove your trustee
• You’re able to change your mind at any time about your beneficiaries
• You can select whether the trust income is taxable to you or your beneficiaries
• You can choose whether you receive all net income from trust assets, or to grant the trustee discretion in distributing the income to you. The attorney notes that in both these instances, the income will be counted for Medicaid eligibility, even if the trustee decides not to actually give you the income.
You can also choose to prohibit the trustee from granting you any trust income, which would ensure it won’t be counted as part of the cost of your care when you’re on Medicaid.
An attorney can advise you further. The key point is that you retain the right to these design choices when using an irrevocable trust for Medicaid planning.
What are the Benefits of Irrevocable Trusts?
If placed in an irrevocable trust, Mr. Silver’s $400,000 in bank accounts and securities and his $500,000 home wouldn’t prevent him from receiving Medicaid. Were he to sell his home in the future, it would still be exempt from capital gains of up to $250,000. When his children – as beneficiaries – sell his home, it would be valued at the market price at the date of gifting and not at his purchase price of $350,000. This means that any capital gains tax they’d pay in future would be minimized or avoided. The assets would be protected from creditors of his beneficiaries too.
Mr. Silver can also specify what the bequests can be used for by his children, be it funding education or buying a home. He even has the right to require that a beneficiary become eligible to receive the gift only if s/he modifies her or his behavior, for example by participating in a drug rehabilitation program. He’s pleased that he can plan now for the money to be an incentive in future, in case he becomes mentally incompetent down the road. Mr. Silver is also able to designate that only blood descendants or specified charities receive whatever isn’t consumed by the initial recipients.
What are the Downsides of Outright Gifting?
The attorney warns Mr. Silver of some of the drawbacks of outright gifting.
Loss of Control: Outright gifts result in the grantor giving up all control over the gifted assets. If assets are transferred to an irrevocable trust instead, then the grantor can retain the right to make important decisions over their use. Additionally, with an outright gift the beneficiary receives all of the income from the gifted assets. With a trust, however, the right to income and the right to principal can be bifurcated. When creating an irrevocable trust for asset protection, the grantor can retain retain the right to receive income from the trust. Even though the grantor won’t have access to the principal the income can help cover the costs of making it through a look-back period should a nursing home be needed within 5 years of the creation of the trust.
No Protection from Loss: Outright gifting leaves the assets susceptible to loss by the beneficiary. The beneficiary may become estranged from the donor and there is no way to ensure that funds are used as the donor intended originally. Additionally, if the recipient dies then the assets will be passed on to their beneficiaries which may not be the outcome that the donor desired. Also, the recipient’s creditors would have access to the funds, putting them at risk of loss if the recipient goes through a bankruptcy or divorce. Using a trust ensures the assets are available for the recipient but protected from creditors, the recipient’s bad decision making, addictions, gambling, etc.
Capital Gains: With outright gifting, if the assets appreciate the recipient may be on the hook for capital gains tax on the difference between the original cost and the current market value. A trust can be structured so that the recipient inherits the property with a fair market value as at the date of the donor’s death.
What Other Services Can a Planner Provide?
Mr. Silver’s elder care attorney/estate planner is aware that the specific language of certain aspects of the trust must be crafted carefully to comply with trust rules of the Tax Code. He is also able to advise whether Mr. Silver needs to file a federal gift tax return for the year when the transfers to the irrevocable trust are completed. Mr. Silver leaves the office secure in the knowledge that his future medical needs are provided for and he’s ensured his children will use his legacy wisely.
It’s evident that it’s crucial to find an attorney with extensive experience in drafting trusts and financial planning. Rapps & Associates, PLLC has a reputation for in-depth knowledge of estate, asset protection and wealth transfer planning. Contact us to discuss your Medicaid and other health planning needs.