Gifting Your House with a Life Estate vs. Medicaid Trust

I recently published an article titled “Don’t Gift Your House To Your Children” which highlighted the pitfalls of gifting your house to your kids versus setting up a Medicaid Trust to own your house, as an asset protection strategy to manage the risk of a long-care care event taking place in the future.  That article prompted a few estate attorneys to reach out to me to present a third option which involves gifting your house to your children with a life estate.   While the life estate does solve some of the tax issues of gifting the house to your kids with no life estate, there are still issues that persist even with a life estate that can be solved by setting up a Medicaid trust to own your house.

In this article, I will cover the following topics:

• What is a life estate?

• What is the process of gifting your house with a life estate?

• How does the life estate protect your assets from the Medicaid spend-down process?

• Tax issues associated with a life estate

• Control issues associated with a life estate

• Comparing the life estate strategy to setting up a Medicaid Trust to own your house

3 Asset Protection Strategies

There are three main asset protection strategies when it comes to protecting your house from the Medicaid spend-down process triggered by a long-term care event:

1. Gifting your house to your children

2. Gifting your house to your children with a life estate

3. Gifting your house to a Medicaid Trust 

Gifting Your House To Your Children

Gifting your house outright to your children without a life estate is probably the least advantageous of the three asset protection strategies.  While gifting your house to your kids may be a successful strategy for getting the house out of your name to begin the Medicaid 5-Year Lookback Period, it creates a whole host of tax and control issues that can arise both while you are still alive and when your children inherit your house after you pass away.

Note: The primary residence is not usually a countable asset for purposes of Medicaid BUT some counties may place a lien against the property for any payments that Medicaid makes on your behalf for long-term care services.  While Medicaid can’t make you sell the house while you are still alive, once you pass away, Medicaid may be waiting to recoup the money they paid, so your house ends up going to Medicaid instead of passing to your children.

Here is a quick list of the issues:

No Control:  When you gift your house to your kids, you no longer have any control of that asset, meaning if the kids wanted to, they could sell the house whenever they want without your permission.

Tax Issue If You Sell Your House:  If you gift your house to your kids and then you sell your house while you are still alive it creates numerous issues.  First, from a tax standpoint, if you sell your house for more than you purchased it for, your children have to pay tax on the gain in the house.  Normally, when you sell your primary residence, a single filer can exclude $250,000 of gain and a married filer can exclude $500,000 of gain from taxation. However, since your kids own the house, and it’s not their primary residence, you lose the exclusion, and your kids have to pay tax on the property as if it was an investment property.

No Step-up In Cost Basis:  When you gift an asset to your kids while you are still alive, they inherited your cost basis in the property, meaning if you paid $100,000 for your house 30 years ago, their cost basis in your house is $100,000.  After you pass away, your children do not receive a step-up in cost basis, which means when they go to sell the house, they have to pay tax on the full gain amount of the property.   If your kids sell your house for $500,000 and you purchase it for $100,000, they could incur a $60,000+ tax bill.

Life Estate Option

Now let’s move on to option #2, gifting your house to your kids with a life estate.   What is a life estate?  A life estate allows you to gift your house to your children but you reserve the right to live in your house for the rest of your life, and your children cannot sell the house while you are still alive without your permission.

Here are the advantages of gifting your house with a life estate versus gifting your house without a life estate:

More Control: The life estate gives the person gifting the house more control because your kids cannot make you sell your house against your will while you are still alive. 

Medicaid Protection:  Similar to the outright gift your kids, a gift with a life estate, allows you to begin the Medicaid 5-year look back on your primary residence so a lien cannot be placed against the property if a long-term care event occurs.

Step-up in Cost Basis:  One of the biggest advantages of the life estate is that the beneficiaries of your estate receive a step-up in costs basis when they inherit your house.   If you purchase your house for $100,000 30 years ago but your house is worth $500,000 when you pass away, your children receive a step-up in the cost basis to the $500,000 fair market value when you pass, meaning if they sell the house the next day for $500,000, there are no taxes due on the full $500,000.   This is because when you pass away, the life estate expires, and then your house passes through your estate, which allows the step-up in basis to take place.

Lower-Cost Option:  Gifting your house to your children with a life estate only requires a simple deed change which may be a lower-cost option compared to the cost of setting up a Medicaid Trust which can range from $1,500 - $5,000. 

Disadvantages of Life Estate

However, there are numerous disadvantages associated with life estates:

Control Problems If You Want To Sell Your House:  While the life estate allows you to live in the house for the rest of your life, you give up control as to whether or not you can sell your house while you are still alive.  If you want to sell your house while you are still alive, you, and ALL of your children that have a life estate, would all have to agree to sell the house.  If you have three children and they all share in the life estate, if one of your children will not agree to sell the house, you won’t be able to sell it.

Tax Problem If You Sell It: If you want to sell your house while you are still alive and all of your children with the life estate agree to the sale, it creates a tax issue similar to the outright gift to your kids without a life estate.   Since you gifted the house to your kids, they inherited your cost basis in the property and would not be eligible for the primary gain exclusion of $250,000 / $500,000, so they would have to pay tax on the gain. 

One slight difference, the life estate that you retained has value when you sell the house, so if you sell your house for $500,000, depending on the life expectancy tables, your life estate may be worth $50,000, so that $50,000 would be returned to you, and your children would receive the remaining $450,000.    

Medicaid Eligibility Issue:  Building on the house sale example that we just discussed, if you sell your house, and the value of your life estate is paid to you, if you or your spouse are currently receiving Medicaid benefits, it could put you over the asset allowance, and make you or your spouse ineligible for Medicaid.  

Even if you are not receiving Medicaid benefits when you sell the house, the cash coming back to you would be a countable asset subject to the Medicaid 5-Year Lookback period, so the proceeds from the house may now become an asset that needs to be spent down if a long-term care event happens within the next 5 years.

Your Child’s Financial Problems Become Your Problem:  If you gift your house to your children with a life estate, similar to an outright gift, you run the risk that your child’s financial problems may become your financial problem.  Since they have an ownership interest in your house, their ownership interest could be exposed to personal lawsuits, divorce, and/or tax liens.

Your Child Predeceases You:  If your child dies before you, their ownership interest in your house could be subject to probate, and their ownership interest could pass to their spouse, kids, or other beneficiaries of their estate which might not have been your original intention.

Medicaid Trust

Setting up a Medicaid Trust to protect your house from a long-term care event solves many of the issues that arise compared to gifting your house to your children with a life estate.

Control:  You can include language in your trust documents that would allow you to live in your house for the rest of your life and your trustee would not have the option of selling the house while you are still living.

Protection From Medicaid: If you gift your house to a grantor irrevocable trust, otherwise known as a Medicaid Trust, you will have made a completed gift in the eyes of Medicaid, and it will begin the Medicaid look back period.

Step-up In Cost Basis:  Since it’s a grantor trust, when you pass away, your house will go through your estate, and your beneficiaries will receive a step-up in cost basis. 

Retain The Primary Residence Tax Exclusion:  If you decide to sell your house in the future, since it’s a grantor trust, you preserve the $250,000 / $500,000 capital gain exclusion when you sell your primary residence.

Ability to Choose 1 or 2 Trustees: When you set up your trust, you will have to select at least 1 trustee, the trustee is the person that oversees the assets that are owned by the trust.   If you have multiple children, you have the choice to designate one of the children as trustee, so if you want to sell your house in the future, only your child that is trustee would need to authorize the sale of the house.  You do not need to receive approval from all of your children like you would with a life estate.

Protected From Your Child’s Financial Problems:   It’s common for parents to list their children as beneficiaries of the trust, so after they pass, the house passes to them.  But the trust is the owner of the house, not your children, so it protects you from any financial troubles that could arise from your children since they are not currently owners of the house.

Protect House Sale Proceeds from Medicaid:  If your trust owns the house and you sell the house while you are still alive, at the house closing, they would make the check payable to your trust, and your trust could either purchase your next house, or you could set up an investment account owned by your trust. The key planning item here is the money never leaves your trust.  As soon as the money leaves your trust, it’s no longer protected from Medicaid, and you would have to restart the Medicaid look back period.

A Trust Can Own Other Assets: Trusts can own other assets besides real estate. A trust can own an investment account, savings account, business interest, vehicle, and other assets.  The only asset a trust typically cannot own is a retirement account like an IRA or 401(k) account. For individuals that have more than just a house to protect from Medicaid, a trust may be the ideal solution.

Comparing Asset Protection Strategies

When you compare the three Medicaid asset protection options:

• Gifting your house to your children

• Gifting your house to your children with a life estate

• Gifting your house to a Medicaid Trust

The Medicaid Trust tends to offer individuals a higher degree of control, flexibility, tax efficiency, and asset protection compared to the other two options.  The reason why people will sometimes shy away from setting up a trust is the cost.  You typically have to retain the services of a trust and estate attorney to set up your trust which may cost between $1,500 - $5,000. The cost varies depending on the attorney that you use and the complexity of your trust.

Does A Trust Have To File A Tax Return

For individuals that are using the Medicaid trust to protect just their primary residence, their only cost may be to set up the trust without the need for an annual trust tax filing because a primary residence is usually not an income-producing property.  However, if your trust owns assets other than your primary residence, depending on the level of income produced by the trust assets, an annual tax filing may be required each year.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

A CFP® Explains: Wills, Health Proxy, Power of Attorney, & Trusts

When we are constructing financial plans for clients, we inevitably get to the estate planning portion of the plan, and ask them “Do you have updated wills, a health proxy, and a power of attorney in place?”  The most common responses that we receive are: 

• “I know we should have but we never did”

• “I did but it was over 10 years ago”

• “I have a will but not a health proxy or a power of attorney”

• “I have heard about trusts, should I have one?”

The Will, Health Proxy, and Power of Attorney are the three main estate documents that most people should have.  In this article I will review: 

• How Wills work and items that you should include in your Will

• Why you should have a Health Proxy and how they work

• Power of Attorney

• The probate process

• Considering a testamentary trust

• Assets that pass outside of the Will

• Revocable Trusts & Irrevocable Trusts

• Estate planning tips

• How much does it cost to establish a will, health proxy, and a power of attorney

Establishing A Will

The most basic estate document that most people are aware of is a written Will.   The Will provides specific guidance as to who will receive your assets after you have passed away.  The Will also establishes who would be the guardian of your minor children should you pass away prior to your children reaching the age of majority.  Without a Will, state laws and the court system that know nothing about you, will decide who receives your assets and who will be the guardian of your minor children; not a situation that most people want. 

The Will can be a very simple document.  If you are married and have children, the Will may state that if you pass away everything goes to your spouse but if both you and your spouse were to pass away simultaneously, the assets go to the children.  For individuals or married couples without children, or for married couples that have been divorced, it’s also critical to have a Will to provide direction as to what will happen to your assets if you were to pass away. 

You can engage an estate attorney to complete a simple Will or if your Will is very simple and straightforward, you may elect to use a do-it-yourself option through a platform like Legal Zoom.   We typically encourage clients to meet with an estate attorney because when it comes to estate planning many people don’t know what questions to ask to get the right documents and plan in place.  If you are married with minor children, and you and your spouse were to pass away leaving all the assets to the kids, with a simple Will, they would have access to their full inheritance at age 18.  An 18 year old having access to large sums of money may not be an optimal situation.   In those cases, you may want to include a testamentary trust or revocable trust in your estate plan to put some restrictions in place as to how and when your children will have access to their inheritance. 

Probate

I'm going pause here for a moment and explain what probate is and the probate process. When someone passes away, all of the assets included in their estate go through what's called a “probate process”.  The probate process is a legal process of accounting for all of your assets, debts, and transferring your assets to the beneficiaries of your estate.  The person listed in your will as the “executor” is responsible for coordinating the probate process.  Depending on the size of the estate, your executor will usually work with an attorney, an accountant, and possibly appraiser, to: 

• Value the assets in your estate

• Work with the courts to process your estate

• Pay outstanding expenses or debts

• Coordinate the transfer of assets to your beneficiaries

Since the probate process is a legal process involving the courts, the process often takes longer than beneficiaries expect.  Individuals will make the incorrect assumption that when you pass away, they just read the will, and your beneficiaries receive the assets within a few days or weeks; unfortunately that's not that case.  It’s not uncommon for the probate process to take 6 to 12 months and there are expenses involved with probating an estate.  If it’s a complex estate, it could take over a year to complete the probate process. 

For these reasons, it’s a common goal with estate planning to find ways to avoid the probate process and pass you assets directly to your beneficiaries.  I will explain more about these strategies later on.  But circling back to our discussion about the Will, if all you have is a Will, when you pass away, the assets in your estate will pass through this probate process. 

Testamentary Trusts

There are a lot of different types of trusts within in estate planning world. One of the most basic and common trusts, especially for individuals with children under that age of 25, is a testamentary trust. A testamentary trust is a trust that is built into your will.  With at testamentary trust, you are not establishing a trust today , but rather, if you pass away, a trust is established during the probate process and you can direct assets to the trust.  Building a testamentary trust into your Will gives you some control over how the assets are distributed to the beneficiaries after you have passed away. 

It's common for individuals or married couples with children under that age of 25, to build these testamentary trusts into their Wills.  I will illustrate how these trusts work in the example below. 

Example: Jim and Sarah have two children, Rob age 14 and Wendy age 8.  Between the value of their house, life insurance policies, and other assets, their estate would total $1.5M.  Jim & Sarah realize that if something were to happen to them tomorrow, they would not want their kids to inherit $1.5M when they turn age 18 because they might not go to college, they may try to start a business that fails, buy a Corvette, etc. In their Will they establish a Testamentary Trust that states that if both parents pass away prior to the children turning age 25, all of their assets will flow into a trust, and that Sarah’s brother Harold will serve as the trustee. Harold as the trustee is able to distribute cash from the trust for living expenses, education, health expenses, and other expenses deemed necessary for the well being of the children. The children will receive 1/3 of their inheritance at age 25, 30, and 35. 

You can design these testamentary trusts however you would like. In the Will you would designate who will be the trustee of your trust and the terms of the trust. 

IMPORTANT NOTE: Testamentary trusts do not avoid probate like other trusts do.  The trust is established as part of the probate process. 

Revocable Trusts & Irrevocable Trusts

It's also common for individuals and married couples to consider establishing either a Revocable Trust or Irrevocable Trust as part of their estate planning.  These are separate from Testamentary Trusts.  Revocable Trusts and Irrevocable Trusts are being established today and assets owned by the trust pass in accordance with the terms set forth in the trust document.   There are material differences between these two types of trusts but some primary reasons why people establish these types of trust are to: 

• Avoid probate

• Protecting assets from a long term event

• Control how and when assets are distributed beyond the date of death

• Reducing the size of the estate

• Advanced tax strategies

Assets That Pass Outside of The Will

There are certain assets that pass outside of the Will.  Many of these “other assets” pass by “contract”, meaning there are beneficiaries designated on those accounts. A common example of assets that pass by contract are 401(k) accounts, IRA’s, annuities, and life insurance.  When you set up those accounts you typically designate beneficiaries for each account and your Will could say something completely different. The assets that pass by contract do not have to go through the probate process unless the beneficiary listed on the account is your estate which is usually not an advantageous election for most individuals. 

Transfer On Death Accounts (TOD)

One of the estate planning strategies that we use with clients is instead of holding an individual investment account in the name of the individual, we will register the account as a “transfer on death” (TOD) account.    If you have an individual brokerage account and you pass away, the value of that account will have to go through probate.  By simply adding the TOD feature to an existing individual brokerage account which lists beneficiaries similar to a 401(K) or IRA account, that account now avoids probate, and passes by contract directly to the beneficiaries.

Depending on the assets that make up your estate, you may be able to setup TOD accounts as opposed to going through the process of setting up trusts but it varies from person to person. 

Power of Attorney

Let’s shift gears now over to the Power of Attorney document.  A Power of Attorney document is important because it allows someone to step into your shoes and handle your financial affairs, should you become incapacitated.   Some common examples are: 

Example 1: If you're in a car accident and end up in a coma, for accounts that are held only in your name, such as a checking account, investment account, or credit card, they will only speak to you.  Being married does not give your spouse access financially to those accounts while you are still alive but your spouse may need access to them to continue to pay your bills or get access to cash to pay expenses while you're incapacitated.   Having a power of attorney document would allow your spouse or trusted individual named as your “agent” to act financially on your behalf. 

Example 2:  Having a power of attorney in place is key for Long Term Care events.  If you have a spouse or parent and they have a stroke, develop dementia, or another health event that renders them unable to handle their personal finances, you could step in as their agent and handle their personal finances.  In long term care situations that can often mean paying a nursing home, applying for Medicaid, paying medical bills, or shifting the ownership of assets to protect from a Medicaid spend down. 

The Power of Attorney can also be built so your agent is not given that power today but rather it would only be given if a triggering event happened sometime in the future.   With this document you really have to name someone you 100% trust.   As financial planners, we have seen cases where there is abuse of the Power of Attorney powers and it’s never pretty.  It's not uncommon for a power of attorney to allow the agent to make gifts as a planning tool, but that might also include gifts to themselves, so you have to fully trust your agent and the powers that you provide to them. 

Health Proxy

The health proxy is usually the least fun estate document to complete but is equally important.  In this document you are naming the individual that has the right to make your health decisions for you if you are incapacitated.  This document spells out what you want and don’t want to have happen if certain health events occur. While it's not uncommon for individuals to be a little uncomfortable completing this document due to the nature of the questions, it's a lot better to complete it now, versus your family members trying to determine what your wishes would be when a severe health event has already occurred. 

The health proxy will list items like: 

• Would you be willing to be put on life support?

• If you could not eat, would you allow them to use a feeding tub

• Resuscitation preferences

• Willingness to accept blood transfusions

Again, not fun things to think about but by you making these decisions while you are of sound body and mind, it takes away the difficult situation where your family members have to decide in the heat of the moment what you would have wanted.  That situation can sometimes tear families apart. 

Keep Your Estate Plan Up To Date

All too often, we run into this situation where a client will acknowledge that they have estate documents, but they were established 20 years ago, and they never made any changes.  It makes sense to meet with your estate attorney and revisit your estate plan: 

• Every five years

• If you move to a different state

• When Congress makes major changes to the estate tax rules

The estate laws vary state by state.  If we have clients that are planning to move and they plan to change their state of domicile to another state, we will often encourage them to meet with an estate attorney within that state once the move is complete.    Congress has also made a number of changes to the federal estate tax laws over the past few years, with potentially more in the works, and not revisiting the estate plan could end up costing your beneficiaries tens of thousands of dollars in estate taxes that could have been avoided with some advanced planning. 

Cost of Estate Documents

The cost of establishing a Will, Health Proxy, Power of Attorney, and Trusts, often varies based on the complexity of your estate plan.   A simple Will may cost less than $1,000 to establish through an estate attorney.   Establishing all three documents: Will, Health Proxy, and Power of Attorney may cost somewhere between $1,000 - $3,000.  While it's not uncommon for individuals to be surprised by the cost of setting up these estate documents, I always urge people to think about the cost of not having those documents in place.  The probate process with professionals involved could cost thousands of dollar, your beneficiaries could lose thousands of dollars in taxes that could have been avoided, not to mention the emotional toll on your family trying to figure out what you would have wanted without clear guidance from your estate documents. Revocable Trusts and Irrevocable Trust

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Should You Put Your House In A Trust?

Should You Put Your House In A Trust?

When you say the word “trust” many people think that trusts are only used by the uber rich to protect their millions of dollars but that is very far from the truth.  Yes, extremely wealthy families do use trusts to reduce the size of their estate but there are also a lot of very good reasons why it makes sense for an average individual or family to establish a trust.   The two main reasons being the avoidance of probate and to protect assets from a long-term care event.  This article will walk you through: 

• How trusts work

• The difference between a Revocable Trust and an Irrevocable Trust

• The benefits of putting your house in a trust

• How to establish a trust

• What are the tax considerations

What Is A Trust?

When you establish a trust, you are basically creating a fictitious person that is going to own your assets.   Depending on the type of trust that you establish, the trust may even have it's own social security number that is called a “tax ID number”.  Here is an example.  Mark and Sarah Williams, like most married couples, own their primary residence in joint name.  They decide to establish the “Williams Family Trust”.  Once the trust is established, they change the name on the deed of their house from Mark and Sarah to the Williams Family Trust. 

Revocable Trust vs. Irrevocable Trust

Before I get into the benefits of establishing a trust for your house, you first have to understand the difference between a “Revocable Trust” and an “Irrevocable Trust”.   As the name suggests, a revocable trust, you can revoke at any time.  In other words, you as the owner, can take that asset back. You never really “give it away”.   Revocable trusts do not have a separate tax identification number.  They are established in the social security number of the owner.  A revocable trust is sometime referred to as a “living trust”.

With an Irrevocable Trust, once you have transferred the ownership of the house to the trust, it’s irrevocable, meaning you are never supposed to be able to take it back. The trust will own that house for the rest of your life.  Now that sounds super restrictive but there are a lot of strategies that estate attorneys use to ease those restrictions and I will cover some of those strategies later on in this article.

In both cases, in trust language, the owner that gave property to the trust is called the “grantor”.  I just want you to be familiar with that term when it is used throughout this article.

So why would someone use an Irrevocable Trust instead of a Revocable Trust?  The answer is, it depends on which benefits you are trying to access by placing your house in a trust.

The Benefits Of A Revocable Trust Owning Your House

People transfer the ownership of their house to a revocable trust for the following reasons: 

• Avoid probate

• They have children under the age of 25

• They want maximum flexibility

Avoid Probate

From our experience, this is the number one reason why people put their house in a revocable trust. Trust assets avoid probate.  If you have ever had a family member pass away and you were the executor of their estate, you know how much of a headache the probate process is.  Not to mention costly.

Let’s go back to our example with Mark & Sarah Williams.  They own their house joint and they have a will that lists their two children as 50/50 beneficiaries on all of their assets.

When the first spouse passes away, there is no issue because the house is owned joint, and the ownership automatically passes to the surviving spouse.  However, when the surviving spouse passes away, the house is part of the surviving spouse’s estate that will be subject to the probate process.  You typically try to avoid probate because the probate process: 

• Is a costly process

• It delays the receipt of the asset by your beneficiaries

• Makes the value of your estate accessible to the public

The costs come in the form of attorney fees, accountant fees, executor commissions, and appraisal fees which are necessary to probate the estate. The delays come from the fact that it’s a court driven process. You have to obtain court issued letters of testamentary to even start the process and the courts have to approve the final filing of the estate. It’s not uncommon for the probate process to take 6 months or longer from start to finish.

If your house is owned by a revocable trust, you skip the whole probate process. Upon the passing of the second spouse, the house is transferred from the name of the trust into the name of the trust beneficiaries.   You save the cost of probate and your beneficiaries have immediate access to the house.

The Difference Between A Trust and A Will

I’ll stop for a second because this is usually where I get the question, “So if I have a trust, do I need a will?”  The answer is yes, you need both.   Anything owned by your trust will go immediately to the beneficiaries of the trust but any assets not owned by the trust will pass to your beneficiaries via the will. Trusts can own real estate, checking accounts, life insurance policies, and other assets.  But there are some assets like cars and personal belongings that are usually held outside of a trust that will pass to your beneficiaries via the will.   But in most cases, people have the same beneficiaries listed in the will and the trust. 

Children Under The Age of 25

For parents with children under the age of 25, revocable trusts are used to prevent the children from coming into their full inheritance at a very young age.  If you just have a will, both parents pass away when your child is 18, and they come into a sizable inheritance between your life insurance, retirement accounts, and the house, they may not make the best financial decisions. What if they decide to not go to college because they inherited a million dollar but then they spend through all of the money within 5 years?  As financial planners we have unfortunately seen this happen.  It’s ugly. 

A revocable trust can put restrictions in place to prevent this from happening. There might be language in the trust that states they receive 1/3 of their inheritance at age 25, 1/3 at age 30, 1/3 at age 35.  But in the meantime, the trustee can authorize distributions for living expenses, education, health expenses, etc.  The options are limitless and these documents are customized to meet your personal preferences.

Maximum Flexibility

The revocable trust offers the grantor the most flexibility because they are not giving away the asset. It’s still part of your estate, it’s just not subject to probate. At any time, the owners can take the asset back, change the trustee, change beneficiaries of the trust, and change the features of the trust. 

The Benefits Of An Irrevocable Trust

Let’s shift gears to the irrevocable trust.  The benefits of establishing an irrevocable trust include: 

• Avoid probate

• They have children under that age of 25

• Protect assets from a long-term care event

• Reduce the size of an estate

As you will see, the top two are the same as the revocable trust. Irrevocable trust assets avoid probate and are a way of controlling how assets are distributed after you pass away. However, you will see two additional benefit listed that were not associated with a revocable trust. Let’s look at the long-term care event protection benefit. 

Protect Assets From A Long-Term Care Event

When individuals use an irrevocable trust to protect assets from a long-term care event, it’s sometimes called a “Medicaid Trust”.    If you have ever had the personal experience of a loved one needing any type of long-term care whether via home health aids, assisted living, or a nursing home, you know how expensive that care costs.  According to the NYS Health Department, the average daily cost of a nursing home is $371 per day in the northeastern region.  That’s $135,360 per year.

For an individual that needs this type of care, they are required to spend down all of their assets until they hit a very low threshold, and then Medicaid starts picking up the tab from there.  Now the IRS is smart.   They are not going to allow you to hit a long term care event and then transfer all of your assets to a family member or a trust to qualify for Medicaid.  There is a 5 year look back period which says any assets that you have gifted away within the last 5 years, whether to an individual or a trust, is back on the table for purposes of the spend down before you qualify for Medicaid.  This is why they call these trusts a Medicaid Trust.

Medicaid Will Put A Lien Against The House

Now, your primary resident is not an asset subject to the Medicaid spend down.  If your only asset is your house and you have spent down all of your other assets that are not in an IRA or qualified retirement plan, you can qualify for Medicaid immediately.  So why put the house in an irrevocable trust then?  While Medicaid cannot make you sell your primary residence or count it as an asset for the spend down, Medicaid will put a lien against your estate for the amount they pay for your care.  So when you pass away, your house does not go to your children or heirs, Medicaid assumes ownership, and will sell it to recoup the cash that they paid out for your care. Not a great outcome.  Most people would prefer that the value of their house go to their kids instead of Medicaid.

If you transfer the ownership of the house to an Irrevocable Trust, you can live in the house for the rest of your life, and as long as the house has been in the trust for more than 5 years, it’s not a spend down asset for Medicaid and Medicaid cannot place a lien against your house for the money that they pay out for your care.

So if you are age 65 or older or have parents that are 65 or older, in many cases it makes sense for that individual to setup an irrevocable trust, transfer the ownership of the house to the trust, and start the 5 year clock for the Medicaid look back period.   Once you have satisfied the 5 year period, you are free and clear.

Frequently Asked Question

When I meet with clients about this, there are usually a number of other questions that come up when we talk about placing the house in a trust.  Here are the most common:

If my house is in a trust, do I still qualify for the STAR and Enhanced STAR property tax exemption?

ANSWER: Yes

If my house is gifted to a trust, do my beneficiaries still receive a step-up in basis when they inherit the asset?

ANSWER:  As long as the estate attorney put the appropriate language in your trust document, the house will receive a step up in basis at your death.

What if I want to sell my house down the road but it’s owned by the trust?

ANSWER:  It depends on what type of trust owns your house and the language in your trust document.  When you sell your primary residence, as a single tax filer you do not have pay tax on the first $250,000 of capital gain in the property. For married filers, the number is $500,000. Example, married couple bought their house in 1980 for $40,000, it’s now worth $400,000, which equals $360,000 in appreciation or gain in value. When they sell their house, they do not pay any tax on the gain because it’s below the $500,000 exclusion.

If a revocable trust owns your house, you retain these tax exclusions because you technically still own the house. If an irrevocable trust owns your house, depending on the type of irrevocable trust you establish and the language in your trust document, you may or may not be able to utilize these exclusions.

Many of the irrevocable trust that we see drafted by estate attorneys that exist for the purpose of avoiding probate and protecting asset from Medicaid are considered grantor trusts. The estate attorney will often put language in the document that protects the assets from Medicaid but allows the grantor to capture the primary residence capital gains exclusion if they sell their house at some point in the future.  But this is not always the case.  If you establish a irrevocable trust for your primary residence, it’s important to have this discussion with your estate attorney to make sure this specific item is addressed in your trust document.

Now, here is the most common mistake that we see people make when they sell their house that is owned by their irrevocable trust.  You put your primary residence in an irrevocable trust six years ago so you are now free and clear on the five year look back period.  You decided to sell your current house and buy another house or sell your house and put the cash in the bank.  At the closing the buyers make the check payable to you instead of your trust.  You deposit the check to your checking account and then move it into the trust account or issue the check to purchase your next house.  Guess what? The 5 year clock just restarted.  The money can never leave the trust. If your intention is to sell one house and by another house, at the closing they should make the check payable to your trust, and the trust buys your next house.

Does the trust need to file a tax return?

ANSWER: Only irrevocable trusts have to file tax returns because revocable trusts are built under the social security number of the grantor. However, if the only asset that the irrevocable trust owns is your primary residence, the trust would not have any income, so there would not be a need to file a tax return for the trust each year.

Are irrevocable trusts 100% irrevocable?

ANSWER: There are tricks that estate attorneys use to get around the irrevocable restriction of these trusts.  For example, the trust could make a gift to the beneficiaries of the trust and then the beneficiaries turn around and gift the money back to the grantor of the trust. Grantors can also retain the right to change who the trustees are, the beneficiaries, and they can revoke the trust.  Bottom line, if you really need to get to the money, there are usually ways to do it.

How To Establish A Trust

You will need to retain an estate attorney to draft and execute your trust document. For a simple revocable or irrevocable trust, it may cost anywhere from $2,000 – $5,000.  Before people get scared away by this cost, I remind them that if their house is subject to probate their estate may have to pay attorney fees, accountant fees, appraisal fees, and executor commissions which can easily total more than that.

In the case of a long-term care event, I just ask clients the question “Do you want your kids to inherit your house that you worked hard for or do you want Medicaid to take it if a long-term care event occurs down the road?”  Most people reply, “I want my kids to have it.” Putting the house in an irrevocable trust for 5 years assures that they will.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

The Medicaid Spend Down Process In New York

You are most likely reading this article because you had a family member that had a health event and the doctors have informed you that they are not allowed to go back home to their house and will need some form of health assistance going forward.  This article was written to help you understand from a high level the steps that you may need to take to get them the care that they need and to get a preview of the Medicaid application process and the spend down process, if that’s the path that needs to be taken.

Everyone is living longer which is a good thing but it creates more complications later in life. It is becoming much more common that people have family members that have a health event in their 80’s or 90’s that renders them unable to continue to live independently. Without advance planning, a lot of the important decisions then have to be made by family and friends so it is important for even younger individuals to understand how the process works because you may be in this situation some day for a loved one.

Do I Have To Apply For Medicaid To Pay For Their Care?

What you will find out very quickly is any type of care whether it's home health care, assisted living, or a nursing home, is very expensive. Very few individuals have the assets and the income to enable them to pay out of pocket for their care without going broke. It's not uncommon for kids or family members to have no idea what mom or dad's income and asset picture looks like. But no one is going to provide you with this information unless you have a power of attorney.

Power of Attorney, Health Proxy, and Will

A power of attorney (“POA”) is a document that allows you to step into a person’s shoes that have been incapacitated. It allows you to get information on their bank accounts, investments, insurance policies, and anything else financially. If you do not have a power of attorney, you need to get one quickly.  A lot of financial decisions will most likely need to be made in a very short period of time. You will need to contact an estate attorney to draft the power of attorney. There are some choices that you will have to make when you draft the documents as to what powers the “POA” will have. They can usually be turned around by an attorney in 48 hours if needed.

While you have the estate attorney on the phone, you also will want to make sure that they have a health proxy and a will. The health proxy allows you to make healthy decisions from a family member if they are unable to do so. While it’s difficult to think about, health proxies will typically list out the end of life decisions. For example, a health proxy may state that mom or dad refuses to have a machine breathe for them if they are no longer able to breathe on their own. The questions are tough to answer but it’s very important to have this document in place.

Home Care, Assisted Living, or Nursing Home

Prior to the health event, mom or dad may have been living by themselves at their house. Now the doctor is telling them that because of the damage done by the stroke, that they will not release them from the hospital until other arrangements are made for their care. There are three options to receive care:

• Receiving care in the home via home care by health aids

• Assisted living facility

• Nursing home facility

People that cannot pay for 100% of their care and that do not have a long term care insurance policy, typically have to spend down their personal assets and then apply for Medicaid.  Now that is said, let's jump right into what is protected and not protected as far as income and assets for Medicaid.

Different Rules For Different States

Each state has different eligibility and spends down rules when it comes to Medicaid. For purposes of this article, we will assume that the person needing the care is a resident of New York. If you live in a different state, the process will be similar but the actual amounts and the definition of "protected" assets may be different. It's usually best to work with a Medicaid planner, estate attorney, or local social services office that is located within your state/county to obtain the rules for your family member that needs care.

The Medicaid Rules In New York

There are different limits based on whether the family member needing care is married and their spouse is still alive or if they are single or widowed. In general, if a couple is married and one spouse needs care, more assets and income will be able to be protected and they will be able to qualify for Medicaid because they recognize that income and assets have to be available to support the spouse that does not need the care. But for purposes of this article, we will assume that mom passed away and dad now needs care.

Asset Limit

In 2018, to qualify for Medicaid, an individual is only allowed to keep $15,150 in assets. The next question I get is "what counts toward that number?" It's actually easier to explain what DOES NOT count toward that number. The only assets that do not count toward that threshold are as follows:

• Primary Residence

• 1 Vehicle

• Pre-Tax Retirement Accounts (if older than age 70½) - (However Required Minimum Distribution goes toward care)

• Irrevocable Trust (Funded at least 5 years ago)

• Pre-paid burial expenses

That's it. If dad has $50,000 in his checking account, $20,000 in a Roth IRA, and a RV, the RV will need to be sold and he will need to spend down the Roth IRA and the checking account until the balance reaches $15,150 in order to apply for Medicaid.

Primary Residence

Very important, while the primary residence is a protected asset for purposes of the Medicaid application, Medicaid will place a lien against dad’s estate for the money that they paid on his behalf. Meaning when he passes away, the kids do not automatically get the house. Medicaid will be first in line after the house is sold waiting to get paid. The amount depends on how much Medicaid paid out. If dad lives in a house that is worth $200,000 and Medicaid during his lifetime paid out $120,000 for his care, when the house sells, Medicaid will get $120,000 and the beneficiaries of the estate will only get the remaining $80,000.

When kids hear this they typically get upset because mom and dad worked their whole life to payoff the mortgage and maintain the house and now they are going to lose it to Medicaid. Is there anything that can be done to protect it? If the house was not put into a Medicaid Trust 5 years before needing to qualify for Medicaid then no, there is nothing that can be done. That’s why advanced planning is so important.

If dad worked with an estate attorney to establish a Medicaid trust 5 years ago, the attorney could have changed the ownership of the house to the trust, once dad makes it by 5 years without a health event, it’s no longer a countable asset for Medicaid and Medicaid cannot place a lien against the house. The question I usually ask our clients is “do you want Medicaid to get your house or do you want your kids to have it?” Most people say their kids but if advanced planning was not completed, you lose this options.

No Gifts To Kids

So what if you change the name on the house to the kids? It's considered a "gift". All gifts made within the last five years are a countable assets. It's called the "5 year look back period". When you apply for Medicaid for dad you have to provide them with a ton of information including 5 years of all statements for bank accounts and investment accounts. Also you have to provide them with copies of all checks written over the past 5 years that were in excess of $1,000. Medicaid is making sure that you did not "give" all of dad's assets away last minute so he could qualify for Medicaid and avoid the spend down.

Income Limits

We have talked about assets but what about income? It's not uncommon for a parent to be receiving a pension and/or social security. They are only allowed to keep $842 per month in 2018. The rest of their income will be applied toward their care. This can create some tough decisions if dad has to go to assisted living or a nursing home and the family has to maintain the house and meet his financial needs on $842 per month. Again, Medicaid it trying to recoup as much as it can to pay for dad's care.

Medicaid Pooled Trust

There are ways to protect income above the $842 threshold through the use of a Medicaid Pooled Trust. Unlike the Medical Irrevocable Trust to protect assets that needs to be established 5 years prior, these trusts can be establish now to protect more income. They work like a special checking account that can only be used to pay bills in dad's name. You can never withdraw cash out of the accounts. As long as dad is considered "disabled" by the social security administration or NYS he may qualify to setup this trust. There are not-for-profit entities that administer this income trust. Basically his income from social security and pension would be deposited to this trust account and then when bills show up for utilities, property taxes, car payment, etc, you submit the bill to the organization that is administering the trust and they pay the bill on behalf of that individual.

Home Care Limitation

Most individuals want to return to their home and have the care provided at their house via home health aids.  This may or may not be an option. It all depends on the level of care needed. If Medicaid will be paying for dad's care, you will need to call the social services office in the county that he lives in. They will send an "assessor" to his house to determine if the living conditions are adequate for home care and they will also determine the level of care that is needed. In general, if the estimated cost of home care is expected to be at least 90% of what it would cost for care at a facility, Medicaid will not pay for home care and will require them to go to an assisted living or nursing home facility.Home health aids typically range in price from $15 - $30 per hour. Assume it cost $25 per hour, if dad needs care 8 hours a day, 7 days a week that would cost $6,083 per month. If you need a nurse or registered nurse to administer medication at the home, you are looking at $40+ per hour for those services.

Steps From Start To Finish

We have covered a lot of ground and this is just a general overview. But here is a general list of the steps that need to be taken assuming dad had a health event and you need to apply for Medicaid on his behalf:

• Contact an estate attorney to establish a power of attorney and requirement for Medicaid application

• Using the POA, begin collecting financial information for the Medicaid process

• Contact the county social services office to request an assessment to determine if home care will be an option if it's in question

• If a spend down is required to qualify for Medicaid, work with estate attorney to develop spend down strategy

• If monthly income is above threshold, determine if a Medicaid pooled trust is an option

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

How Are Trustee Commissions Calculated & Taxed?

If you are the trustee of a trust, in most cases, you are allowed to be paid a commission from the trust assets.  States have different rules with regard to the trustee commission calculation.  This article will assist you in understanding how the commission is calculated, how the payments are taxed, the rules for commissions not taken in past years, and how the trust commissions are split between multiple trustees. 

Trust Document

The trust document usually has a special section that addresses commissions paid to the trustee.  It’s common for the trust document to include language that states that “the trustee shall receive annual commissions in the same manner and at the same rates as prescribed for testamentary trustees under the laws of the State of (Name of State)”.

For New York the formula is as follows:

1.05% of the first $400,000

0.45% of the next $600,000

0.30% of the rest

For example, a trust has $500,000 in assets as of December 31st, the calculation would be as follows:

$400,000 x 1.05% =          $4,200

$100,000 x 0.45% =          $   450

Total Commission:           $4,650

The trustee would be eligible to receive $4,650 from the trustee assets as their commission for the year.

How Are Commissions Taxed?

Commissions paid by the trust to the trustee are reported as income by the trustee on their personal tax return.  The trust deducts the commission paid as an expense.  We frequently receive the question, “does the trust have to issue a 1099-MISC tax form for the commission that was paid to the trustee?”    Many tax professionals take the position that a 1099-MISC is not required to be issued because serving as trustee does not meet the definition of a “trade or business” which is the prerequisite for issuing a 1099-MISC tax form. 

More Than 1 Trustee

What happens where there is more than 1 trustee?  Do the trustees have to split the commission equally?  The answer is “it depends”.   It depends on the size of the trust and the number of trustees.

Again, I’m referencing New York State law her.  The rules will vary for by state.  For trusts with under $100,000 in assets, each trustee gets the full commission.  If a trust has $80,000 in assets and there are 3 trustees, each trustee would receive $840 ($80,000 x 1.05%).

For trusts with assets between $100,000 – $400,000, if there are one or two trustees, each trustee is entitled to a full commission.  If there are 3 or more trustees within this asset range, the single trustee commission is divided equally between the trustees.  I don’t necessary understand the logic behind if there are two trustees the commission is doubled but if there are 3 trustees, a single commission payment is split between the trustees.  But that’s how the law is written.

For trusts with more than $400,000 in assets, if there are 1 – 3 trustees, each trustee is entitled to the full commission amount.  If there are more than 3 trustees, again, the commission is split equally amongst the trustees.

Can You Waive The Commission Payment?

As the trustee, you can voluntarily waive the commission payment.  The money simply remains in the trust.  Why would a trustee do this?  Some trustees just don’t need the income. In some situations, the parents will setup a trust, they have more than one child, but only one of the children serves as trustee.   The child that serves as trustee may decide to waive the commission payment to avoid conflict with their siblings about “taking money from mom and dad’s trust”.

Another reason for waiving the commission payment is the trustee may purposefully want to realize that income at a later date.  Whatever the reason, I just wanted you to know that waiving the commission payment is an option.

Back Payments

We will frequently get the following question:

“I have been the trustee of this trust for the past 10 year but I have never taken a commission.  Am I still entitled to the trustee commissions for past 10 years even though I did not take them?”

The answer is “yes”.  The trustee is still entitled to receive those commissions for past years even though they did not take them in the year that they were due.   The trustee would just need to be able to produce the records necessary to calculation the trustee commission for all of the past years.

In these cases, remember, commission payments to the trustees are taxed at ordinary income tax rates to the trustee. If you decide to “catch-up” on past commissions that are due to you and you receive $30,000 in trustee commissions in a single tax year that could bump you up into a higher tax bracket.  It may make more sense from a tax standpoint to spread those past commission payments over the course of the next few years to reduce the tax hit.

Disclosure: This article is for educational purposes only. For legal advice, please consult an attorney. 

Michael Ruger

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Do Trusts Expire?

Do trusts have an expiration date after the death of the grantor?  For most states, the answer is “Yes”.  New York is one of those states that have adopted “The Rule Against Perpetuities” which requires all of the assets to be distributed from the trust by a specified date.

The Rule Against Perpetuities

For most states, the trust assets have to be distributed no later than the “lifetime of those then living plus 21 years.”   In other words, the trust asset must be distributed 21 years after the death of the youngest beneficiary listed in the trust document.   For example, if I setup a trust with my children listed as beneficiaries, after my passing the trust assets would have to be distributed no later than 21 years following the death of my youngest child.

Per Stirpes Beneficiaries

Some trust documents have the children listed as beneficiaries “per stirpes”.  This mean that if a child is no longer alive their share of the trust passes to their heirs.  In many cases their children.  If the beneficiaries are listed in the trust document as per stirpes beneficiaries then you may be able to make the argument that the “youngest beneficiary” is really the grandchildren not the children which will allow the trust to retain the assets for a longer period of time.  Typically trusts do not allow the perpetuity rule to extend beyond their grandchildren.

Consult An Estate Attorney

Trust can be tricky and the language in a trust document is not always black and white,  so it’s highly recommended that you consult with an estate attorney that is familiar with the estate laws for you state of residence and can review the terms of the trust document.DISCLOSURE:  The information listed above is not legal advice. For legal advice, please consult your attorney. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.