One very common question that I get is “Should I give all of my property to my children?” Most of my prospective clients know that there is a five-year lookback period for long-term care Medicaid. So they figure that the best way to pay for long-term care is to give everything to their children, pray that they don’t need a nursing home for at least five years, and then shift that cost to the tax payers. But long-term care planning is not that simple. Before you give away your assets, there are a lot of things to consider.
Giving Everything Away and Hoping You Don’t Need Long-Term Care is Not a Plan
You need a plan to pay for long-term care. As many as 75% of seniors will require some level of long-term care. Gifting can be part of your plan. But it is not the entire plan. Your plan could include some type of long-term care insurance, keeping sufficient funds to pay for a certain period of care, and a plan to protect certain assets. Protecting specific assets can involve a gift.
The Government Might Not Pay for Your Care
Many people are shocked to find out that Medicaid does not help pay for assisted living facilities in North Carolina. The program that helps low-income seniors pay for assisted living is called State-County Special Assistance. There are very strict income limits for Special Assistance. At this time, if your gross income before deducting Medicare premiums is more than $1,248.00, you will not qualify for assistance with standard assisted living under any circumstances. If your income is more than $1,580 per month, you will not qualify for assistance with a memory care unit. The reality of this is that if you need assisted living, you make more than income limits but less than the cost of care, there is not a government program (other than VA benefits for qualified veterans) that will help pay those costs. So in order to plan properly for this type of care, you must either find a way to pay for it yourself or buy an insurance policy that will pay. This requires planning. If you gave all of your money to your children, how will you pay for help?
Your Plan Can Include Preservation of Certain Assets
As part of your overall plan to pay for long-term care, you may wish to preserve your family farm, your home, or a certain amount of cash for your beneficiaries. The earlier you make your plan, the better the chance that you have of protecting your property. When you determine what property you wish to protect, then you have to decide how to go about doing it. It is at this point that you should consider the use of an irrevocable trust for Medicaid planning.
Irrevocable Trusts are an Important Tool in Long-Term Care Planning
Outright gifts are simple and have minimal transaction costs. But gift transaction costs are only a small part of what needs to be considered in planning. Many important benefits that can result from gifting in trust are lost by outright gifting. Prior to state implementation of the federal Deficit Reduction Act of 2005 (DRA), Medicaid law contained a bias against trusts. Most transfers to trusts had a 5-year lookback period, whereas there was only a 3-year lookback period for non-trust transfers. This different standard induced many people to elect outright gifting over gifting in trust. However, the DRA imposed a 5-year lookback period for all transfers. Removal of the bias against trusts made irrevocable trust planning a viable alternative.
Trusts Provide Asset Protection while Outright Gifts Expose Your Property to Your Beneficiaries’ Present and Future Creditors
A primary benefit of gifting in trust is to protect the gifted assets from the creditors and predators of the beneficiaries. This is accomplished by special provisions in the trust that make trust assets not subject to attachment, foreclosure, garnishment, or a laundry list of undesirable actions by the creditors of the beneficiaries. It can also protect your property from being lost in a divorce. If you give your home to your children outright, the property could be taken by creditors, tied up in a divorce, or encumbered by judgments.
Gifting in Trust Preserves the Section 121 Exclusion of Capital Gain on Sale of Principal Residence While Gifting Outright Does Not
Section 121 of the Tax Code creates an exclusion from capital gains tax of up to $250,000 of capital gain in the taxpayer’s principal residence when it is sold if the taxpayer owned and lived in the house at least two of the past five years before the sale. If there are two qualifying co-owners, they can each exclude $250,000 of gain upon sale in such circumstances. A trust can preserve this benefit if it is a grantor trust. On the other hand, if you give your residence outright to your children, they will not qualify for the Section 121 exclusion unless they live in the house for two of the last five years. If you paid $25,000 for your home in 1965, have lived there since, and sell it in 2016 for $225,000, you will not owe taxes on the gain. If you give that same home to your son in 2016 and he sells the home two years later to help pay for your nursing home, he will owe taxes on $200,000 of capital gain. That would be a $30,000 mistake.
Gifting in Trust Preserves the Step-Up of Basis While Gifting Outright May Not
When an appreciated asset is included in a decedent’s taxable estate for federal estate tax purposes, it receives step-up (or down) of basis to the date of death value under Section 1014 of the Tax Code. But when assets are given away, the recipient receives the assets with the donor’s adjusted cost basis. If, however, something pulls the assets back into the taxable estate of the donor upon the donor’s death, the donee will own the asset at that point with the donor’s date of death value as his or her basis, rather than the donor’s original adjusted cost basis. For appreciated assets, such as your home or stocks that you have owned for a long time, obtaining step-up of basis can be a huge benefit for minimizing or eliminating capital gains tax when your children later sell the assets. This benefit of step-up in basis can easily be lost by outright gifting. However, a provision in an irrevocable trust that pulls the property back into the taxable estate of the settlor upon the death of the settlor can preserve step-up of basis for benefit of the donee. This can also be accomplished by retaining a life estate while giving a remainder interest. With the amount of assets that can pass free of federal estate tax being well beyond the value of most Medicaid planning clients’ estates, maintaining a step-up of basis is an important benefit to design into the trust.
Gifting in Trust Gives You the Ability to Select Whether the Trust Income is Taxable to You or to the Beneficiaries
Grantor trusts are treated by the Tax Code as “owned” by the settlor (also called the grantor) for income tax purposes. The significance of grantor versus non-grantor trust status is a big topic, and can only be touched upon lightly here. But the choice of whether a trust will be a grantor or non-grantor trust and how that will be accomplished are key design decisions. For example, it may be important that income generated in the trust not be taxed to the settlor. This requires non-grantor trust status, which necessitates that every trust provision that would cause grantor trust status be avoided in the drafting of the trust. In other situations, however, grantor trust status is important as a goal for tax reasons, or if the settlors are to receive income from the trust. Trusts give that flexibility, while outright gifts do not.
Gifting in Trust Gives You the Ability to Make the Trust Assets Non-countable for your Beneficiaries’ Medicaid or SSI While an Outright Gift Does Not
An outright gift or bequest from a donor, such as a parent, to a child who is disabled, or who becomes disabled, may make that child ineligible for means-based governmental benefits. In such situations, unless the beneficiary creates a “self-settled special needs trust,” the gift typically gets consumed for his or her care. Once they are gone, the donee goes back onto the governmental benefits. So in this case, the government is really the recipient of your gift.
It is better planning for the gift or bequest to be made in an irrevocable special needs trust for benefit of the disabled beneficiary, so the gift will be managed to enhance the living conditions of the disabled beneficiary by paying for things that the governmental benefits do not pay for.
If a disabled person becomes entitled to an outright gift or bequest, or an outright gift or bequest recipient later becomes disabled, depending on the age of the disabled person, it may be possible to establish a “self-settled special needs trust” for the disabled beneficiary. Such trusts (funded with assets of the disabled person) must contain a provision stating that upon the death of the disabled beneficiary any remaining trust assets must pay back the state up to the full amount of Medicaid benefits received by the beneficiary, and only after the state is reimbursed may any excess pass to other beneficiaries such as other relatives.
Gifting in Trust Gives You the Ability to Specify Terms and Incentives for Beneficiaries’ Use of Trust Assets
Many parents or grandparents desire to give their children or grandchildren incentives to use property wisely. Such goals may be as simple as that the gifts or bequests may only be used for the recipients’ education, to finance a career change or buy a home. Or the goals may be more serious. For example, if a beneficiary has an alcohol problem, you could require that he participate in a rehabilitation program before becoming eligible to receive a gift or bequest. Such planning goals of a client almost always indicate an irrevocable trust with beneficiary incentive provisions as the vehicle to implement the plan. This is completely compatible with Medicaid asset protection planning for seniors at the same time. It is not compatible with an outright gift.
Gifting in Trust Gives You the Ability to Decide Which Beneficiaries Will Inherit Upon Your Death while Outright Gifts Do Not
An irrevocable trust created for Medicaid planning utilizes a retained Limited Power of Appointment, which preserves for you the power to decide who will receive the benefits of the trust upon your death, how much they will receive, and in what way they will receive it. You can specify that your assets go to anyone other than your creditors, your estate and its creditors. Most often, however, the class of potential appointees consists of your descendants, certain other relatives, or charities. The specific language of the limited power of appointment must be crafted carefully with regard to the grantor trust rules of the Tax Code. You can also look at this as a “power of disappointment,” because you truly retain the power to disinherit someone who acts badly. This should keep your children coming to Thanksgiving dinner.
Gifting in Trust Gives You the Ability to Decide Ability to Determine Successor Beneficiaries, while Outright Gifts Do Not
A major concern in any estate planning is who will be the ultimate beneficiary of what you leave to a beneficiary. One thing that often drives my clients to use trusts is thinking about what will happen to their assets upon the death of their children. If you give your daughter your farm and $100,000, and she dies before her husband, there is a good likelihood that your son-in-law will end up with the property, rather than your grandchildren. When you give a gift outright, the recipient has control, not you. The recipient’s creditors or divorcing spouse may also gain control over the assets gifted outright. If you would prefer to designate that only your descendants or certain charities will receive what is not consumed by the initial recipient, an irrevocable trust is a key tool in creating such a plan.
The use of irrevocable trusts in long-term care planning provides many opportunities to create benefits beyond simply transferring assets. If care is taken to include the desired provisions, an irrevocable trust, can greatly enhance the value of your long-term care planning beyond what can be accomplished through outright gifting.
We are happy to you with considering whether an irrevocable trust may be appropriate for you.