Using trusts in Medicaid planning

With careful planning, you may be able to preserve some of your estate for your children or other heirs while meeting Medicaid’s low asset limit.

The problem with transferring assets is that you have given them away. You no longer control them, and even a trusted child or other relative may lose them. A safer approach is to put them in an irrevocable trust. A trust is a legal entity under which one person — the “trustee” — holds legal title to property for the benefit of others — the “beneficiaries.” The trustee must follow the rules provided in the trust instrument. Whether trust assets are counted against Medicaid’s resource limits depends on the terms of the trust and who created it.

A “revocable” trust is one that may be changed or rescinded by the person who created it. Medicaid considers the principal of such trusts (that is, the funds that make up the trust) to be assets that are countable in determining Medicaid eligibility. Thus, revocable trusts are of no use in Medicaid planning.

Income-only trusts

An “irrevocable” trust is one that cannot be changed after it has been created. In most cases, this type of trust is drafted so that the income is payable to you (the person establishing the trust, called the “grantor”) for life, and the principal cannot be applied to benefit you or your spouse. At your death the principal is paid to your heirs. This way, the funds in the trust are protected and you can use the income for your living expenses.

For Medicaid purposes, the principal in such trusts is not counted as a resource, provided the trustee cannot pay it to you or your spouse for either of your benefit. However, if you do move to a nursing home, the trust income will have to go to the nursing home.

You should be aware of the drawbacks to such an arrangement. It is very rigid, so you cannot gain access to the trust funds even if you need them for some other purpose. For this reason, you should always leave an ample cushion of ready funds outside the trust.

You may also choose to place property in a trust from which even payments of income to you or your spouse cannot be made. Instead, the trust may be set up for the benefit of your children, or others. These beneficiaries may, at their discretion, use the property for your benefit if necessary. However, there is no legal requirement that they do so.

One advantage of these trusts is that if they contain property that has increased in value, such as real estate or stock, you (the grantor) can retain a “special testamentary power of appointment” so that the beneficiaries receive the property with a step-up in basis at your death. This will also prevent the need to file a gift tax return upon the funding of the trust.

Remember, funding an irrevocable trust within the five years prior to applying for Medicaid (the “look-back period”) may result in a period of ineligibility. The actual period of ineligibility depends on the amount transferred to the trust.

Testamentary trusts

Testamentary trusts are trusts created under a will. The Medicaid rules provide a special “safe harbor” for testamentary trusts created by a deceased spouse for the benefit of a surviving spouse. The assets of these trusts are treated as available to the Medicaid applicant only to the extent that the trustee has an obligation to pay for the applicant’s support. If payments are solely at the trustee’s discretion, they are considered unavailable.

Therefore, these testamentary trusts can provide an important mechanism for spouses to leave funds for a surviving institutionalized husband or wife that can be used to pay for services that are not covered by Medicaid. These may include extra therapy, special equipment, evaluation by medical specialists or others, legal fees, visits by family members, or transfers to another nursing home if that became necessary.

Special needs trusts

The Medicaid rules also have certain exceptions for transfers for the sole benefit of disabled people under age 65. Even after moving to a nursing home, if you have a child or other relative who is under age 65 and disabled, you can transfer assets into a trust for his or her benefit without incurring any period of ineligibility. If these trusts — also called “supplemental needs trusts” — are properly structured, the funds in them will not be considered to belong to the beneficiary in determining his or her own Medicaid eligibility.

To find out whether a trust is the right Medicaid planning strategy for you, talk to your attorney.