When Trusts Work for Planning Purposes – and When They Don’t

Whenever a thorny problem arises, whether for Medicaid planning purposes or estate planning, one predictable question has been “Can’t this be solved by establishing a trust?”  The answer is not as direct as it might seem.  There are different kinds of trusts and the laws and regulations change.  Even when they work, Congress or a state legislature or a Court decision might disrupt everything and make it time to start again.

Here are, however, some general ideas to navigate the difficult subject of trusts.

Revocable vs. Irrevocable Trusts.  A revocable trust, as the name suggests, can be changed by the person (the “Settlor” or Trust Maker) who made it.  After drafting, executing and funding the trust, the Trust Maker can change his or her mind about the terms or discontinue the trust entirely.  Because the trust can be changed, for tax purposes and for many other purposes, a revocable trust is treated generally as though the Settlor did not give the assets away in the first place.

A revocable trust does not in and of itself save federal estate taxes unless it is drafted with the same kind of language and terms that would be used in a Will and unless you are extremely wealthy, few people pay federal estate taxes now anyway.  It does not save Pennsylvania inheritance taxes either if the decedent was a Pennsylvania resident.  For long term care, assets are still considered available, so revocable living trusts do not help for Medicaid planning.

There are still some reasons why in the appropriate case to use a revocable living trust.

One is to have a mechanism in place that can manage and continue when one or both of the Trust Makers become disabled especially if the Makers may move to other states. Note, however, that some of this might be done with well drafted Wills and Powers of Attorney.

Working on the drafting of such an engagement might force people to think through what they really want.  Facilitating transfer of real estate in different states can be another goal.

In order to work, assets need to be transferred into the name of the trust.  Setting up a living trust without putting anything into it is like constructing a box without depositing anything into it.  Living trusts only work well with a good plan.

An Irrevocable Trust, on the other hand, is one that, once established and funded, cannot be changed.  Setting up an Irrevocable Trust is a lot like giving the assets away and is similarly treated for tax and other purposes.

Here are some reasons for establishing an Irrevocable Trust.

Creditor Protection –  If assets are given away directly, they may be subject to the claims of creditors or potential creditors of the trust beneficiaries.  Giving the assets to a trust, if properly done, can in some cases, insulate the assets from claims against the trust beneficiaries and preserve available funds.

Tax Structuring –  Some irrevocable trusts such as those gifting through a trust to minors either generally or for specific purposes and specialized trusts benefiting charities may have significant tax benefits.

Irrevocable Income Only Trusts – These trusts may be used in connection with Medicaid structuring and have various names.  Sometimes referred to as a Medicaid Intentionally Defective Grantor Trust (MIDGT) or an IOT, generally they should be considered only where there are enough assets or resources in addition to those being placed in trust to carry the Trust Maker through five years of

nursing home care.   It is assumed in settling up the trust that the Trust Maker will initially be paying for his or her own care.  The MIDGT is to protect additional assets when there is longer term care over five years.

Long term care insurance can be combined with a MIDGT especially if it can carry through five years.

There are other successful strategies to deal with Medicaid and the five year lookback than Trusts.  Usually, you should not simply transfer all the assets out of the owner’s name and wait five years.  This could have significant and catastrophic effect in some cases.  The important point is to get professional advice when help is needed.

About the Author Janet Colliton

Esquire, Colliton Law Associates, P.C. Janet Colliton has practiced law for over 38 years, 37 of them in Chester County, Pennsylvania, a suburb of Philadelphia. Her practice, Colliton Law Associates, PC, is limited to elder law, Medicaid, including advice, applications and appeals, and other benefits planning including Veterans benefits, life care and special needs planning, guardianships, retirement, and estate planning and administration.

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