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Irrevocable Trusts – Not as Frightening as You Might Think!: Part 1
Many people hear the words “irrevocable trust” and think that the irrevocable nature of the instrument requires inflexibility and rigidity, or that they will lose control over their assets. This is a common myth. As this series of articles will show, an irrevocable trust may enable an individual to retain a significant degree of control over assets during life, while providing for protection from creditors and reducing tax liability for the person’s heirs following death. Putting assets into an irrevocable trust also may help to reduce the risk that a child’s creditor or ex-wife will take the assets while the parent is alive.
One very big concern that has been growing recently is the possibility that a person’s hard-earned assets will be taken to cover the costs of necessary long-term medical care, leaving nothing to transfer to the healthy spouse, children, or other loved ones. Long-term care costs have been rising, and the law allows Medicaid to look back up to five years to take assets that have already been transferred. For that reason, it is important to come up with a strategy to protect these assets while a person is healthy, before the need for long-term medical care arises. The longer that a person waits to protect assets, the more likely it is that the assets will not be protected. One way for parents to avoid having their assets confiscated to pay for long-term medical care is to place the assets in an irrevocable trust as part of a comprehensive estate plan.
Consider a hypothetical married 70-year-old couple in good health with two children that lives in Massachusetts. They own a home worth approximately $500,000 and have approximately $300,000 in other assets. The couple wants to protect their assets from being taken to pay creditors, including long-term care providers, and to avoid the costs associated with probate. One solution for this couple may be to transfer all or some of their assets to an irrevocable trust. The husband and wife would be the donors to the trust and would choose an independent trustee to manage their trust during their respective lifespans. The trustee, would have the ability to pay necessary expenses from the trust assets. Using an independent trustee can give a person a much greater sense of safety than transferring assets to outright children as gifts.
In this example, when the husband and wife pass away, any assets put into an irrevocable trust are not included in the person’s estate for the calculation of Medicaid assistance, the estate tax, or probate. In Massachusetts, the state can only take assets included in the probated estate to pay for long-term medical care. The probated estate includes assets owned individually at the time of death. Assets owned by an irrevocable trust are not owned in the individual’s name and therefore are not part of the probated estate. Therefore, these assets are not subject to Medicaid’s estate recovery provision in Massachusetts. That means, ultimately, that assets in the trust will be preserved for the person’s heirs.
One the best ways to protect your assets from the Medicaid spend down (i.e. avoid the 5-year look back rule) is to utilize the best irrevocable trust in America – the Ultra Trust®
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Many older Americans are concerned that they may suffer some disability that requires them being accommodated in a nursing home. This is not an attractive prospect for at least two reasons. First, nursing home care usually involves some loss in personal autonomy. Second, the care is very costly, estimates ranging from $60,000 to over $140,000 per annum, depending mainly on the level of care and specific location of the nursing home. Nobody expects to need to go into a nursing home, but unfortunately, the statistics are that every one of us has a 50% chance of needing to go into a nursing home due to a health issue.
Placing assets into an irrevocable trust is the best strategy. It not only protects family assets from creditors, it also eliminates the countable assets for Medicaid eligibility purposes and hence accelerates the time when Medicaid benefits can kick-in.
An irrevocable trust is a legal structure that cannot be amended or undone once signed into existence. It is a structure recognized by Medicaid administrators as being validly used by families to protect assets from the nursing home spend-down.
Establishing an irrevocable trust and placing a portion of family assets in that trust is an effective strategy for protecting those assets from creditors. Those assets remain ring-fenced beyond the reach of creditors. It is not unusual to transfer the major portion of family assets into the trust, even the family house, so as to leave only a small amount of assets outside the trust.
A transfer into an irrevocable trust can be considered a gift for Medicaid eligibility purposes. This gift status/condition works as a significant negative for people applying for Medicaid assistance. In particular, both “penalty period” and 60 months “look-back period” rules apply.
For example, assume a new irrevocable trust is created and $200,000 is transferred into that trust so as to leave only a minimal amount of family assets outside the trust. This structure is created on 1 January of Year 2001. The state of residency of the trust beneficiaries has a “penalty divisor” of $5,000, meaning there is a one month penalty period for every $5,000 of gift value.
In this scenario, let’s assume the penalty period is 40 months, calculated as $200,000 / $5,000 = 40. The penalty period will begin to apply any time within the so-called look-back period. For any gift made on or after 8 February, 2006, the look-back period extends for 5 years. So if a trust beneficiary applies for Medicaid at any time before 2 January of Year 6, the trust beneficiary will be confronted with a 40 month penalty period, or self payment period, that begins on the date an application for Medicaid assistance is made, but is pro-rated. To repeat, the penalty period begins from the date an application for Medicaid assistance is lodged. So if the application for assistance is lodged six months into Year 5, the trust beneficiary will need to wait 4o months from that time before being eligible for Medicaid assistance or they can self pay for year 5 and after the 60 month look back period lapses, they can apply and be qualified for Medicaid. This example highlights the need to plan and establish an irrevocable trust well ahead of the time Medicaid assistance is expected to be needed for the most comprehensive protection.
If the beneficiary needs nursing home care during the 5 year look-back period and there are no funds available to pay for that care because they have all been placed in the trust, a common tactic is for other family members to finance that interim care. It may be possible to draft the trust deed so as to allow the trust to distribute income to those family beneficiary members to cover for this eventuality.
A Medicaid irrevocable trust is a binding, rigid structure for the outside world and relatively flexible for the beneficiaries when drafted correctly. If assets placed in the trust are suddenly needed, they will be difficult to access by outside creditors, but the assets can be accessed by the beneficiaries if implemented properly. Thus, it is critical to have an expert do the trust writing and in some instances, maintain some assets outside the trust. Trust assets will no longer be Â“ownedÂ” by the person that established the trust, although they may still receive the benefit of the assets as a beneficiary. They will, in time, upon the grantorÂ’s death, transfer to the beneficiaries in accordance with the terms in the trust.