Medicaid Trusts

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A trust preserves the assets inside of it from the claims of third parties. A son or daughter who is the trustee does not own the assets as an individual. Instead, they own them as the trustee of the trust. This is an identity separate from their individual self. If the son or daughter divorces or gets sued, then the angry ex-spouse or creditor has a claim against them as an individual, not against them as the trustee. Thus, the soon to be ex-spouse or creditor cannot gain access to the funds. If the son or daughter dies, then the assets do not go into their estate because the son or daughter as an individual does not own them. Instead, a successor trustee named in the trust takes over management of the assets.

An irrevocable, self-settled trust serves as a good instrument for holding the gifts. It helps to reduce the chance that the gifts may be lost to claims of third parties. To understand why it works well, let’s look at some of the Medicaid rules on trusts.

Medicaid recognizes 5 types of trusts. Four of these will not help the folks we normally assist in these circumstances. The one trust that can help is a “self-settled trust established on or after August 11, 1993.”

This “Category Two” trust has three main characteristics. First, the assets of an individual who applies for or receives Medicaid form all or part of the trust. This means it must be “self-settled.” Second, a will does not establish the trust. Third, the nursing home resident, their spouse, authorized agent, or a person acting for the nursing home resident or spouse sets up the trust.

Our clients can use this trust. They want to take their money, set it aside now, and protect it from the claims of outsiders. The Category Two trust permits this to happen.

Additional rules for Category Two trusts encourage irrevocability and elimination of the donor parent as a beneficiary or trustee. If we make the trust revocable, then permitting the parent to change it causes the assets to be considered available for their use. In the words of Medicaid, “[t]he corpus of the trust is considered a resource available to the individual.”We also cannot let the parent have the right to any money from it. The rule states “[i]f there are any circumstances under which payment from the trust could be made to, or for the benefit of, the individual, the portion from which payments could be made is considered a resource available to the individual.”

These rules drive us towards a self-settled, irrevocable trust over which the parent has no right to demand funds as a beneficiary or as a trustee. These are not terms that anyone would want. We all want complete control of our assets. These requirements prevent the parent from maintaining the control they normally have over their money. All their adult lives a parent-controlled their money and got it when they wanted it. Medicaid denies this normality.  This is a radical lifestyle change.

Nevertheless, a Category Two irrevocable trust, which we call a “Medicaid trust,” is the best tool available for holding the gifts. It places the assets outside of the parent’s control, and it protects them from the claims of third parties.  This promotes eligibility for Medicaid and increases the chances the funds will be available to pay expenses during the ineligibility.

The trust only works if the child is trustworthy. The parent must have complete faith the trustee (normally the child) would make the funds available because the parent has no power to demand the money. This is no worse a position, though than if the parent gave the assets outright to the child. Whether the parent makes gifts to the child as an individual or to them as trustee of the trust, the result is the same. The parent intended to give the money away gave it away, and the child accepted it. This completes a gift that transfers title to someone else. The parent would have no power to demand back the funds if they gave it to their child as an individual. The parent also has no power to demand the money from the child as trustee.

We do not have to strip the parent of all control. To the contrary, we can give Mom or Dad meaningful influence and power. We include in the Medicaid trust the “power to say no.” We do this by requiring the trustee to give the parent notice whenever the trustee wishes to mortgage or sell any assets. The parent has the right, for 10 days, to stop the transaction. This does not violate any Medicaid rules that could somehow make the assets “available” for the parent and cause a loss of benefits. This gives the parent some influence over the situation. If the trustee wants to buy penny stocks or something else risky, the parent can say no. If the trustee wants to sell the house, the parent can say no. This power to maintain the status quo can provide some folks with enough comfort that they can proceed with the gifts. For other folks with more trust in their children, it adds assurance to make them feel more secure.

We also give the parent the ability to change the Trustee or the beneficiaries. However, they cannot name themselves in these roles.  The ability to change the beneficiaries causes the trust to be “intentionally defective” and makes it a grantor trust for IRS purposes. This means that the transfer of assets into the trust is not a completed gift for tax purposes.  This allows the beneficiaries to receive a stepped-up basis on any property owned by the trust at the time of the parent’s death.  It also allows for the use of the IRS Code §121 exclusion if the property is sold during the parents’ lifetime, thereby saving capital gains taxes upon the first $250,000 of gain upon the home’s sale (if a single parent) or up to $500,000 of gain if both parents are still alive.  This also allows the trust to run under the parents’ social security numbers so that a separate tax identification number is not necessary.  This means that no separate tax return will be necessary, and any taxable income is passed on to the parent(s).

For most Medicaid trusts, the child is the trustee and the parent (or parents) is the settlor. The parent transfers their assets into the trustee’s name. Normally the trustee and the other children have the right to income and principal while the parent is alive. If the parent needs money, then the trustee makes a distribution to themselves or siblings, then they make it available to the parent. When the parent dies, then the trust terminates and distributes the remaining assets to the beneficiaries the parent chose when they established the trust.

Attorneys who read this may be concerned the trustee has a “power of appointment” that causes the assets in the trust to be includable in the trustee’s estate for gift or estate tax purposes. This is rarely a problem.  Effective for tax years beginning in 2018, the federal government raised the lifetime gift and estate tax exemption to $11.18 Million, subject to adjustments with the cost of living index. This level of wealth surpasses that of nearly all of our clients. Moreover, folks in this wealth range generally do not need Medicaid planning. They have enough resources to pay for the nursing home and leave a legacy. If in some rare case this power of appointment issue came into play, we could get around the problem by requiring any distributions to the trustee to require the permission of one of the siblings. This would insert an adverse party that would cure the ill.

Another concern may be that one can only give away $15,000 per person per year without filing a gift tax return.This should not be a problem, either. Very few persons doing a Medicaid plan would give away more than $11 Million. Consequently, we may have to file a return for the parent making the gifts directly to children, but no tax would be due. A parental gift to one of our Medicaid trusts would be an incomplete gift and not trigger a duty to file a return. As for the children who receive distributions from the trust and make them available for a parent, this should not pose difficulties. One can spend an unlimited amount on medical expenses, like nursing home costs, without the $15,000 annual limit. Further, if there are multiple beneficiaries, the trustee can take turns making distributions to beneficiaries, who can then use their annual gifting limit.

Oftentimes, a Medicaid plan involves only a home and few other assets. For cases in which the trustee makes no distributions, trust management is simple.

Some nursing home residents may want a Medicaid trust, but they cannot name a child as trustee. The child may not be good with money. The child may be impaired. Or the parent may not have enough trust to feel comfortable with the child in this position. This is not necessarily a show stopper. An alternative is naming a bank as trustee. It has solvency requirements and consistent monitoring, thereby being less risky than having a person hold the funds. One can expect to pay several thousand dollars a year for this service.  If one can afford it, then it can be worth it.

In one of our cases, we used a bank trustee for our client, an elderly lady with Parkinson’s disease and nearly $800,000. She had a significant risk of a lengthy nursing home stay. Her two daughters were not suitable candidates to hold the funds. One had debt problems. The other had children in college receiving financial aid. Control of the assets could terminate this assistance. We established a Medicaid trust with a bank as the trustee. The trustee had discretion to make distributions to the daughters, who could then utilize the assets, if necessary, to pay for items needed by the Mother. This arrangement permitted the retention of the assets in trust, yet did not place the assets in the hands of the two daughters who were not suitable candidates to serve as trustee.

 

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