People often wonder about the value of using irrevocable trusts in Medicaid planning. Certainly, gifting of assets can be done outright, not involving an irrevocable trust. Outright gifts have the advantages of being simple to do with minimal costs involved, including the cost of preparing and recording deeds and the cost of preparing and filing a gift tax return. Many financial institutions have their own documents they use for changing ownership of assets so there are typically no out-of-pocket costs for the transferor.
So, why complicate things with a trust? Why not just keep the planning as simple and inexpensive as possible? The short answer is that gift transaction costs are only part of what needs to be considered. Many important benefits that can result from gifting in trust are forfeited by outright gifting. These benefits are what give value to using irrevocable trusts in Medicaid planning.
Prior to state implementation of the federal Deficit Reduction Act of 2005 (DRA) in recent years, federal Medicaid law contained a bias against trusts. Most transfers of assets to trusts had a 5-year lookback period, whereas there was a 3-year lookback period for non-trust transfers. This different standard induced many clients to elect outright gifting in preference to gifting in trust. The DRA leveled the playing field by imposing a 5-year lookback period for ALL transfers. Removal of the bias against trusts shifted the discussion of elder law attorneys with clients to the real benefits of gifting in trust versus gifting outright.
Key benefits of gifting in trust are:
- Asset protection from future creditors of beneficiaries
- Preservation of the Section 121 exclusion of capital gain upon sale of the settlors’ principal residence (the settlor is the trustmaker)
- Preservation of step-up of basis upon death of the trustmakers
- Ability to select whether the trustmakers or other lifetime beneficiaries of the trust will be taxed as to trust income
- Ability to design who will receive the net distributable income generated in the trust
- Ability to make assets in the trust noncountable in regard to the trustmakers’/beneficiaries’ eligibility for means-based governmental benefits, such as Medicaid and Supplemental Security Income (SSI)
- Ability to determine who will receive any trust assets after the deaths of the trustmakers
- Ability to change (through the reservation of a power of a limited testamentary power of appointment that is exercised in the trustmakers’ other estate planning documents) which beneficiaries will receive what share, if any, of remaining trust assets after the deaths of the trustmakers
As discussed above, the use of irrevocable trusts in Medicaid planning, as in other fields of estate planning, provide many opportunities to create benefits beyond simply transferring assets.