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When timing is everything, trusts are vital tool to control inheritances

by Robert Bailey | Contributor
April 21, 2022

There are many tools at your disposal when it comes to estate planning. Yet many individuals, regardless of their situation, set up their estates in the same predictable manner with all assets distributed outright under their last will and testament to its beneficiaries. That's because the focus is often spent on who the beneficiaries will be and what they will get, but not how and when they will receive their inheritance.

As a result, individuals often fail to consider whether their estate plan could benefit from a versatile instrument such as a trust. While trusts come in a variety of shapes and forms, generally, a trust is a legal entity under which one person, a trustee, holds legal title to property for the benefit of others, beneficiaries. The trustee is bound by the rules provided in the trust that are created by the grantor, the person whose assets are being placed in the trust.

While sometimes overlooked, trusts can be an important tool in your estate planning arsenal. Especially in certain circumstances. Trusts can be uniquely used to provide an individual with control as to how and when their assets are passed to another person. With trusts, you have the flexibility of creating it during your lifetime or after your passing as part of your estate itself, known as a testamentary trust. Utilizing trusts gives an individual significant control over the timing of inheritances. This has significant implications for both the grantor and the trust's beneficiaries. Let's discuss how and why a trust may be used to control the timing of an inheritance.

Using trusts to control timing of inheritances for Medicaid planning

If timed properly, trusts can be a vital tool to ensure your assets aren't depleted while still qualifying for Medicaid. Medicaid is often used by older adults as their primary means of health coverage and long-term care. When planning to apply for Medicaid, there are certain income and asset restrictions that may impact your ability to qualify. Although Medicaid varies from state to state, individuals applying for Medicaid generally are restricted to having no more than $2,000 in assets. There are certain exceptions, such as an individual's primary residence, vehicle or wedding rings. Nonetheless, it doesn't take a significant amount of additional assets to exceed the Medicaid limits. If this occurs, you have two options. You can either spend down the assets or have an estate planning strategy to protect them. Utilizing a trust can help ensure that you qualify for Medicaid while simultaneously protecting your assets from being depleted for medical coverage.

In order for a trust to shield your assets from Medicaid eligibility, it must be irrevocable. That is, the person who is setting up the trust will not have the ability to change or rescind it after it is created. This does not mean you do not get to benefit from the assets in trust entirely. Depending on the type of trust set up, the grantor can still use the income produced by the trust. However, the grantor and their spouse are absolutely prohibited from access to any of the principal once the trust is created. In addition, the income produced from the trust assets are not fully protected from paying for medical expenses such as if you were required to move into a nursing home. While these restrictions exist, the trust can still be designed to allow the grantor to continue to control the timing of any inheritance from it. The grantor can designate its beneficiaries as well as either prohibit or permit the trustee to make distributions to beneficiaries other than their spouse, during the grantor's lifetime.

Hands holding a cut out paper family

For Medicaid planning purposes, timing is incredibly important. Any transfer, even into a trust, is subject to a five-year look-back period for Medicaid qualification purposes. When applying for Medicaid, Medicaid will look back to check and see if any of the applicant's assets were gifted or sold under market value in the last five years. While there are other factors that are at play, the important takeaway is that assets transferred during this look-back period can result in a period of Medicaid ineligibility. For this reason, an irrevocable trust for Medicaid qualification should be planned well in advance of when it's anticipated that you'll need to apply for it.

There is an exception. The transfer of assets into a trust for the benefit of another person does not always trigger a five-year look-back period. Special needs trusts are one example in regard to Medicaid planning. Let's say you have a child who is disabled. You can set up a special needs trust, if done properly, without being subject to the five-year look-back period. In addition, the assets within the trust will not be considered to belong to that beneficiary in making a determination of their Medicaid eligibility as well.

In addition to the timing of the initial trust being set up, also be aware of Medicaid's elective-share requirements. When a Medicaid recipient's spouse passes away, they must take an elective share against the estate. If a Medicaid recipient does not do so, it is considered a transfer of assets and subject to transfer penalty rules. This is another situation in which a trust is advantageous. Disinheriting a spouse will not protect their Medicaid eligibility. However, a properly drafted trust can continue to protect your estate while ensuring your surviving spouse is able to qualify for Medicaid. Again, controlling the timing of the inheritance can have a significant impact on your estate as well as future beneficiaries. Instead of having the money distributed to the government, it can be held in trust and preserved for another generation.

Qualifying for Medicaid is not only a consideration for the grantor. Trusts can be used to provide an inheritance to a beneficiary while shielding it from Medicaid. An income-only trust is often used in these scenarios when Medicaid qualification is a concern. Similar to those set up for the benefit of the grantor, the trust would prohibit the individual from receiving the trust's principal but would provide the income the principal produces. Just be aware, most states have an income limit as well, so make sure the trust does not produce income that leads to exceeding that limit. Either way, if the beneficiary of the trust needs to enter a nursing home and apply for Medicaid, the principal within the trust is protected from these costs.

Testamentary trusts can also be used to protect your assets and control the timing of an inheritance. For instance, a trust can be created for one's spouse with the goal of protecting the spouse from being disqualified from Medicaid. The rules that govern Medicaid provide what is known as a “safe harbor” rule for testamentary trusts created for a spouse. As long as the trust is set up to provide the spouse support at the sole discretion of the trustee, the funds are considered unavailable for Medicaid purposes. While there are many reasons to create this type of trust, one is that it allows you to ensure that your spouse can have services not covered by Medicaid paid for.

At the end of the day, any type of trust set up for Medicaid planning purposes can have a two-fold benefit. First, the obvious reason is that it helps you or a loved one qualify for Medicaid. Secondly, it preserves assets for your future beneficiaries. A properly executed trust will prevent what's known as estate recovery. Basically, when a Medicaid recipient passes away, the decedent's state that provided their benefits will attempt to collect a reimbursement for payments they made toward long-term care. This is typically done thorough one's estate. A properly set up trust will protect assets from this attempted collection.

Using trusts to control timing of inheritances for special needs purposes

Trusts can also be beneficial if you have a loved one with special needs. Special needs trusts are typically used to leave money to a disabled individual who cannot earn a sufficient amount of income or live on their own. These irrevocable trusts provide for a beneficiary with special needs while ensuring they do not lose any government benefits they receive, like Medicaid or Supplemental Security Income (SSI). Not only does it protect your beneficiary from losing government benefits, but it also allows the grantor to have a certain level of control over the timing of the inheritance being distributed. Instead of providing the money in one lump sum, it is controlled under the terms the grantor set up in the trust that could last for a potentially long time.

In a situation where one wants to provide long-term support to a special needs beneficiary, an individual can set up a special needs trust that directs its trustee to use to pay directly for services and needs of the beneficiary as they arise. Essentially, it is designed so that their inheritance can be utilized over a long period of time and only to supplement, not jeopardize, any benefits already being provided by the government.

Setting up a special needs trust can preserve an inheritance and allow it to be used for an extended time to pay for things such as caregiving, education, therapy, clothing, furniture and more. When planning a trust, be fully aware of the extent a special needs trust can be used and its limitations. For instance, a special needs trust cannot be used to pay for household repairs, food or monthly household bills, including rent and mortgage.

Just like other trusts, the grantor has control over when they want their beneficiary to receive their inheritance. The trust can be set up during the grantor's lifetime or can also be a part of one's overall estate. Proper trust and estate planning for a special needs beneficiary can give you the peace of mind that your inheritance will not be unnecessarily depleted and that your loved one will be cared for both now and into the future.

Using trusts to control the timing of inheritances for other purposes

While Medicaid planning and special needs beneficiaries are two big reasons for utilizing trusts in your estate plan, there are other practical benefits from the use of a trust. To determine if a trust may be helpful, you need to evaluate the amount you are planning to give each beneficiary against other factors such as the beneficiary's age, family and financial situation. If an individual is aware of or suspects a beneficiary has financial or personal issues, a trust can protect their inherited assets from perils such as divorces, lawsuits and creditors. By setting up a trust and controlling the timing of the inheritance, you can help protect assets that would otherwise be depleted when these types of issues arise.

Unfortunately, sometimes controlling the timing of an individual's inheritance is simply due to having spendthrift heirs or other precarious situations that make you concerned to give your entire inheritance in a lump sum. In situations like these a grantor has a few options for timing the inheritance to prevent wasteful spending by the beneficiary. First, the grantor could set up a lifetime trust in which no lump sums are provided, and all spending must be approved by the trustee. This type of trust can protect the assets from potentially bad decisions by the beneficiary as well as harmful outside influences. You can further control the ultimate timing of this inheritance by specifying who is to receive any remaining funds left in this trust when the beneficiary dies. Another option is to set up the trust so that it distributes portions of the inheritance to its beneficiary in stages. Often, this is done when you have a young beneficiary or you are simply concerned that the money will be spent too quickly. In these situations, a trust could split up the income in thirds giving the beneficiary a third of the trust at three different ages.

Just remember, when it comes to trusts there are some potential downsides as well. First, trusts can be subject to legal challenges if poorly written, too strict or unreasonable. Also, there are likely going to be additional costs such as accounting, legal and trustee fees that will often continue throughout the lifetime of the trust. Finally, be aware of the tax obligations that result from a trust. Some trusts are taxed directly while some pass through and are the direct responsibility of the beneficiary.

While utilizing trusts can be beneficial, be aware of which assets are appropriate to be included in a trust and which are not. Real estate and securities are great assets to have in a trust. Controlling the timing of these inheritances within a trust can yield significant tax advantages as opposed to transferring them outright to your beneficiaries. Assets such as retirement accounts, deferred annuities and government bonds should be distributed in a different manner since placing them within a trust will result in immediate income tax liability.

Conclusion

Trusts are a great tool and can be especially vital in certain estate planning situations. Like other aspects of your estate plan, be aware of all the implications of using trusts as a tool to distribute your inheritance. The irrevocable trusts we have been discussing are very rigid. Once you place the money in the trust you cannot simply take it back out for some other purpose. Make sure you not only plan for your estate but also your current needs. If you decide to create an irrevocable trust, make sure you have ample additional funds as well.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

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