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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.
Asset Protection and land trusts is an important topic for many people because the home is typically the largest asset of most households, yet few understand the risk they take in holding title in their name (John Doe and Jane Doe) or in the name of a revocable land trust. Protecting the marital home form potential risk is a challenging task throughout out the family holding period, from marriage, to teenage kids, to personal guarantee of a business or loan, to empty nesting. The risk is within the family, i.e. threat of divorce or separation, to outside the home i.e. as your teenage kids beginning to drive or as they begin to entertain other kids on your property, presenting you with maximum creditor risk exposure from unwanted or unpleasant events, i.e. throwing a party and one of your guests gets into a car, has an accident and kills the passenger or turns them into quadriplegics.
When devising a plan to protect the personal residence, the place most people begin is to look at the homestead exemption. Every state has a minimum amount of protection by the mere filing of an exemption certificate. The homestead exemption is quite limited in most states typically from $4,000 to $125,000 to unlimited exemption (Florida and Texas). But unless you live in those unlimited homestead exemption states, the homestead is not an asset protection device worth the filing fee. Find more about the pro’s and con’s of homestead protection here
Tenants by the entirety
Most states allow married couples to own title in their home as tenants by the entirety. This type of ownership is “only between married couples” meaning that each spouse has the right to enjoy the underlying property by the “entirety” and when one of the spouses dies, the other inherits the property by the entirety.
Tenancy by the Entirety has the following characteristics:
Tenancy by the Entirety may only be created by Husband and Wife.
Tenancy by the Entirety offers automatic rights of survivorship. The property is automatically transferred to the spouse at the death of the other spouse.
Neither spouse may transfer or convey title to a third person without consent of the other spouse. This method provides slightly better protection over joint tenancy and tenants in common if only one of the spouses incurs a liability. Property right is not divisible or alienable. Neither spouse can sell or encumber the property without the other’s approval, however, smart attorney’s just sue both spouses in most cases in order to avoid this potential problem.
Property is subject to joint creditors including the IRS.
Summary of owning property as Tenants by the entirety: its better than a stick in the eye, however, it is not available in most states, and it does NOT protect assets from joint creditors. Don’t look to Tenants by the Entirety as an asset protection plan for your personal residence
Divisibility of trust assets dependent upon irrevocable nature of trust
Further reviewing the facts of the Epperson case, while the trusts being referenced were initially irrevocable trusts, the divisibility of the trust assets depended upon whether the trusts were irrevocable at the time of divorce. If a sufficient reason could be found to revoke the trusts in the divorce case, the trusts could be revoked, and the trust assets could be divided. In this case, because the trustee’s of the irrevocable trusts are the husband and wife, this opens the ability to break up the trust assets if certain criteria are met because the spouses maintained control.
While seeking to terminate the trusts, the husband in this case sited a specific Montana statute allowing the court to order termination. The statute provides:
(1) Except as provided in subsection (2), if all beneficiaries of an irrevocable trust unanimously request it, they may compel modification or termination of the trust upon petition to the court.
(2) If the continuance of the irrevocable trust is required to carry out a material purpose of the irrevocable trust, the trust cannot be changed or eliminated unless the court, in its discretion, determines that the reason for doing so under the circumstances outweighs the interest in accomplishing a material purpose of the trust if an irrevocable trust is properly set up, this only happens in less than 3% of cases. Under this section, the court absolutely does not have discretion to terminate a trust that is subject to a valid restraint on transfer of the beneficiary’s interest as provided in part 3. Continue reading: Equitable Distribution Case: Termination of an Irrevocable Trust
Rocco Beatrice, CPA, MST, MBA, Managing Director, Estate Street Partners, LLC.
Mr. Beatrice is an asset protection award winning trust and estate planning expert.
Montana adheres to the overriding rule: assets owned by an irrevocable trust are property of the trust, while property owned by a revocable trust are property of the grantors or spouses. In re Marriage of Malquist, 227 Mont. 413, 739 P.2d 482 (1987). Since the Epperson’s irrevocable trusts at issue were, in fact, irrevocable trusts, the assets within the irrevocable trusts were not divisible property.
However, this conclusion would hold true only as long as the irrevocable trusts themselves stood intact. The second exception to the major rule against the division of third-party assets recognizes that the conveyance of the assets into the irrevocable trust itself can be attacked and rescinded annulled if consideration is not legitimate and at market value. If sufficient reason can be found under the law to terminate the third party’s ownership interest after the conveyance, the property may revert back to the parties. This is one reason an independent trustee with critical spendthrift clauses are necessary to withstand these challenges because the independent trustee is a fiduciary with sole responsibilities of the protecting the assets in the trust for the beneficiaries. If the trustee does anything against his fiduciary obligation, like disperse funds outside of his obligations, he can go to jail for breaching his duty. Continue reading: Dividing Irrevocable Trust Assets or Property
Rocco Beatrice, CPA, MST, MBA, Managing Director, Estate Street Partners, LLC. Mr. Beatrice is an asset protection award winning trust and estate planning expert.