To preserve one’s assets while still qualifying for long-term care benefits from the government, many individuals approaching retirement opt to gift a property, insurance, or another asset to a family member. While on the surface, it seems like a smart move to remain eligible for veterans’ benefits or Medicaid, but there is a smarter way to hold on to these assets.
If one is looking for a way to retain assets while receiving federal benefits, one may want to consider an irrevocable trust. A well-prepared irrevocable trust enables one to control where assets go and how they are distributed so one does not lose them to pay for care.
A trust is a type of financial relationship between three people. The person who funds the trust is called the settlor, trustor, or grantor. The trustee manages the trust, and the beneficiary is the person receiving the assets. As the name suggests, an irrevocable trust cannot be revised or revoked without the consent of the trustee and beneficiary.
There are two types of irrevocable trusts. An irrevocable living trust is when the grantor creates and activates the trust while he or she is alive. For that reason, these assets are not subject to the probate process. Spousal lifetime access trusts (SLATs) and irrevocable life insurance trusts are two examples of living trusts.
The second trust is an irrevocable testamentary trust. This type of trust is created during the grantor’s life, but only activated upon his or her passing. An irrevocable testamentary trust is part of a will and these assets are not exempt from probate. A common example of this type would be a trustee named to manage the property one leaves for his or her children.
With a gift, the grantor retains absolutely no control over what happens to those assets. The person who receives them could become estranged, lose them to bad investments, or hand them over to creditors. If the beneficiary dies or divorces, the gifted assets may go to the ex-spouse or child. There are no guarantees that these assets will be available to the grantor if the grantor needs them for any reason.
An irrevocable trust gives the trustor a certain amount of control over how the assets are distributed and how they are to be used. If the trustor designates an additional third-party as a trust protector, that person can act on his or her behalf to revise the amount or frequency of payments and remove a beneficiary or trustee.
Irrevocable trusts cannot be amended or revoked, that is the primary difference between the two. However, there are some other notable differences as well.
Unlike assets of a certain amount surrendered to irrevocable trusts, assets in a revocable trust are not subject to gift tax. Also, revocable trust assets are not protected from creditors.
When it comes to taxes, accounting for assets in a revocable trust is easier. These assets are considered as the grantor’s income and do not require a separate tax identification number. An irrevocable trust requires an individual tax identification number and possibly a separate tax return.
Revocable trust assets are included in the grantor’s taxable estate while they are not with an irrevocable trust. An elder law lawyer can help one bypass this provision with bypass trust planning. He or she can also clarify applicable state and federal estate planning laws to avoid a costly tax blunder.
Another benefit with an irrevocable trust is that the grantor can retain any income produced by the trust. While he or she can no longer have access to the principal, he or she can make some bit of income regardless. Some people feel a peace of mind earning some income while they no longer have immediate control over these assets.
An irrevocable trust offers several tax advantages over a direct gift, one involves taxes. If the settlor includes a provision that income tax on the trust is deferred until the beneficiaries receive the income, he or she will receive considerable tax benefits. Clients with sizeable portfolios find gifting assets to an irrevocable trust for beneficiaries helps avoid high federal estate tax for any gifts over the IRS-permitted lifetime tax-free gift limit.
Some professionals, like business owners or health care providers, are simply more vulnerable to lawsuits and judgements because of the work that they do. Putting assets in an irrevocable trust ensures that they cannot be taken by creditors to satisfy a judgement or a court order. There are a few exceptions to this rule, but in most cases, these assets are protected in this way.
Certainly, an Irrevocable trust is an ideal solution for many seniors looking for a way to preserve assets that they have worked hard to grow. However, there are some disadvantages to consider as well before making these important decisions:
Irreversible: In many cases, without the consent of the trustee and beneficiary, irrevocable trusts cannot be changed. One’s financial picture may not reflect one’s needs in five or 10 years. The lack of flexibility offered by an irrevocable trust is something worth considering.
Lack of control: Once assets are turned over to an irrevocable trust, one is no longer able to access or manage them. Surrendering property is a decision that should never be taken lightly, even if one has faith in a trustee.
Costs: Irrevocable trusts come with some added fees. In addition to the initial cost of creating the trust, there are accounting costs for paying taxes and other payments and ongoing payments to the trustee for managing the trust.
Five-year rule: If one needs Medicaid within five years of surrendering assets to an irrevocable trust, one is required to repay any transfers one has made within this five-year period. One must pay dollar-for-dollar for the cost of nursing home care. Only once those payments are satisfied, one becomes eligible for Medicaid.
If one has reviewed all options and determined this option makes the most sense, it is time to create an irrevocable trust. Since these agreements are especially complex, it is always a good idea to seek the counsel of a seasoned estate planning attorney to manage the nuances of an irrevocable trust. One needs to name a trustee to manage the trust and one or beneficiaries. An attorney will establish the terms of the trust and the uses for assets.