Elder law is among the most rewarding areas of law. Today, approximately one in seven people is an elder and some figures project this population to reach approximately 98 million by the year 2060. These numbers are also an indication that your elder law practice will be very lucrative for many years to come. There is no question that there is plenty of reward — both personally and financially — for elder law attorneys. But when it comes to the unique knowledge base that’s necessary to succeed, there is a lot that must be learned and understood.
Trusts can be among the most intimidating parts of an elder law practice, particularly for new or transitioning elder law attorneys. However, in order to make your practice successful it’s important to understand the different types of trusts and how they can benefit — or harm — a particular client. Aging comes with many legal and quasi-legal concerns that are specific to older Americans and while there are plenty of “typical” scenarios when it comes to elder law planning there are also plenty of unique circumstances. These factors all necessitate an understanding of the various types of trusts and how they can benefit your clients.
If you’re confused about the different types of elder law trusts, you’re not alone. In this article, we’ll go over the different types of trusts that you will need to understand in order to best serve your clients and help them make sound decisions into their retirement years and beyond. We’ll cover the Medicaid Asset Protection Trust, Medicaid Family Protection Trust, Veterans Asset Protection Trust, Parental Protection Trust, Grantor and Non-Grantor Trusts, and the Qualified Disability Trust. Having a better understanding of these different elder law trusts, will lead to a more successful and more lucrative practice and help you to retain elder law clients and attract plenty of new business.
The Medicaid Asset Protection Trust
Medicaid asset protection, or helping your clients ensure that their assets don’t make them ineligible for Medicaid, is among the most common issues you’ll encounter as an elder law attorney. Therefore, the Medicaid Asset Protection Trust is one of the most used Medicaid planning strategies posed as a solution to this issue. It is also one of the most complex trusts, however, so it’s important to understand as much about it as you can before discussing it with your clients.
The Medicaid Asset Protection Trust has many benefits, as well as some potential drawbacks. It’s certainly not suited to every client looking to protect his or her Medicaid eligibility, but it may be the best option for certain clients.
First and foremost, the Medicaid Asset Protection Trust offers your clients an alternative to more expensive long-term care insurance because it allows them to qualify for Medicaid while still protecting their assets. This is beneficial for many reasons, including sheltering clients from the extremely high cost of long-term care, which can also be difficult to qualify for depending on age and health status at the time of application. It also doesn’t force your client into Medicaid.
There are tax benefits associated with the Medicaid Asset Protection Trust as well. It offers an alternative to simply gifting assets to loved ones and waiting for those to be spent down to make a client eligible for Medicaid coverage. If your client were to remove assets from his or her countable estate for Medicaid purposes and gifted those assets, there would be negative tax consequences including a gift tax liability. Furthermore, simply gifting an asset would result in that asset losing its step-up in basis for income tax purposes, which can equal large capital gains taxes once the asset is sold. By placing assets in a Medicaid Asset Protection Trust, the tax liability is removed at the time of the transfer and the asset will receive its regular step-up in basis at the time of the grantor’s (or client’s) death.
Potential drawbacks to the Medicaid Asset Protection Trust
As mentioned, there are some potential drawbacks to this type of trust. The most significant is that your client will lose significant control over any assets because they are considered outright gifts. Therefore, your client — the grantor — can no longer make important decisions over their use as he or she would be able to if the assets were placed in an irrevocable trust, for example. The loss of this control is precisely what enables the asset to be shielded from Medicaid recovery. While the grantor may be the income beneficiary of the trust, he or she is relinquishing the right to remove any of the trust property and place it directly back into his or her name because of the stipulation that the property must remain in the trust.
Implications of Medicaid’s 5-Year lookback period
This trust can impact your client’s Medicaid eligibility so it’s critical to be aware of the potential implications of Medicaid’s five-year lookback period. Because Medicaid can look back over a period of up to five years when determining whether or not a person qualifies for coverage, your client must create the trust, transfer the assets to it (fund the trust), and not have a need for Medicaid for at least five years. After the five-year mark of the funding of the trust, the client will be fully protected and will be eligible for Medicaid.
If your client needs Medicaid before the five years are up, they can choose to become a private pay patient for the gap in years necessary to reach the five-year mark. Alternately, they can opt to have Medicaid assess a penalty period, where they will not receive benefits for a certain amount of time. The penalty period is determined based on the amount of assets transferred and the amount of time that has passed since the transfer.
When should you recommend the Medicaid Asset Protection Trust?
Overall, the Medicaid Asset Protection Trust is well-suited to clients who are near retirement age, have no immediate health care crisis and are looking to protect assets from high tax liability. Your client will need to understand that he or she will be giving up control of what happens to the assets. It is an appealing option for clients that want to keep their options open when it comes to controlling what portion of assets can be used to pay for long-term care and whether or not those loved ones will be involved in that care if and when the need arises.
It’s important to advise your clients about possible future scenarios and the possibility of running out of money should a serious health issue arise.
The Medicaid Family Protection Trust
The Medicaid Family Protection Trust is another of the possible strategies that comes up in elder law Medicaid planning. It’s typically suited to clients interested in protecting their own assets and those of their children or beneficiaries from falling into unintended hands. This type of irrevocable trust can protect clients’ assets from creditors, or anyone that may seek assets as a result of an unpleasant or contentious family situation, such as a child’s divorce.
As an elder law attorney you may find that you are often focusing on negative scenarios, such as long-term care and end-of-life decisions. The Medicaid Family Protection Trust allows you to shift the focus to a more positive goal of helping your client protect his or her family, however. While clients aren’t always eager to face the idea of a potential future need for long-term care, they are willing to talk about their families and protecting their own legacy from any creditors or other threats. The Medicaid Family Protection Trust also provides protection of assets if and when there is a need for Medicare coverage.
This trust can be beneficial for younger retirees that want protection from the many unexpected scenarios that can arise. It also includes trusts for lifetime beneficiaries to ensure that asset protection extends beyond the client — or grantor’s — death.
Potential drawbacks to the Medicaid Family Protection Trust
It’s important to note that the Medicaid Family Protection Trust requires the appointment of a distribution trustee, which can be viewed as a drawback to some clients because they view this as complicated. In reality, however, choosing a distribution trustee isn’t complicated at all because the person your client appoints can be any non-family member and it doesn’t have to be a legal representative or banking institution.
Implications of Medicaid’s 5-Year lookback period
As with the Medicaid Asset Protection Trust, it’s important to be aware of Medicaid’s 5-year lookback period. Although younger clients are far less likely to need nursing-home care, it’s still important to be aware that Medicaid can look back over a period of up to five years when determining eligibility for Medicaid benefits.
Therefore, your client must not have a need for Medicaid for at least five years after assets are transferred to the trust. After that five-year mark, he or she will be fully protected and can qualify for Medicaid without needing to use trust assets to pay for care.
If your client needs Medicaid before the five-year period ends, he or she can choose to become a private pay patient until the five-year mark is reached, or to have Medicaid assess a penalty period, and forgo receiving benefits for a certain amount of time. The penalty period is determined by the amount of assets transferred and the amount of time that has passed since the transfer.
How the trust works while Grantor is living and after Grantor’s death
Lifetime beneficiaries of the Medicaid Family Protection Trust are either the grantor's children or chosen individuals. The grantor him or herself is not a beneficiary.
Responsibilities are split between the Regular Trustee and Distribution Trustee. The Regular Trustee manages all assets, and the Distribution Trustee is the person authorized to make distributions. Distributions can be made to any one or more of the lifetime beneficiaries in equal, or unequal, amounts regardless of needs, according to the Distribution Trustee’s discretion. This essentially creates a third-party trust and safeguards assets for the benefit of the lifetime beneficiaries as long as the grantor is living.
When the grantor dies, the trust is divided into shares for named individuals or for the grantor's descendants. In the case of the latter, division of the distribution is based on the descendant distribution option that was selected when the trust was first established. The trust is divided into equal shares, regardless of the descendant distribution option if all children are still living.
Each child's share is held in trust, and each child has the authority to appoint his or her own Distribution Trustee. While a child cannot force a distribution, he or she can exercise discretion in removing the Distribution Trustee and appointing a new one. In the case that the child is acting as his or her own regular Trustee, a beneficiary controlled trust that is asset protected has been created. Therefore, the child can manage the assets, but only the Independent Distribution Trustee can make distributions.
If the child dies, shares are divided among his or her descendants and held in trust under the same terms. Therefore, asset-protected trusts are created for each child's family and if the trust divides into shares for named individuals, each share will is held in trust.
When should you recommend the Medicaid Family Protection Trust?
The Medicaid Family Protection Trust can serve as a safeguard to protect assets in any scenario where a client is concerned about protecting his or her legacy from unpleasant or unforeseen future circumstances. In terms of Medicaid planning strategies, the client must be willing to appoint a distribution trustee and be comfortable with the concept of an ongoing trust.
The Veterans Asset Protection Trust
Serving Veterans can be beneficial in adding a niche to estate planning as an elder law attorney. The Veterans Asset Protection Trust is a beneficial option for clients who are wartime Veterans or the surviving spouses of a wartime Veteran. It is an intentionally defective grantor trust that is designed to meet the eligibility requirements from the Veterans Administration (VA) of a complete gift or complete relinquishment.
Often times, a residence is a Veteran’s most significant asset. And as long as that home is retained, it is considered a “non-countable resource,” and therefore cannot preclude your client from VA eligibility. However, if your Veteran client is collecting a monthly pension benefit, and later sells the home, any proceeds would disqualify him or her from receiving further Veterans’ pension benefits until proceeds were spent down to an allowable level.
The benefit of a Veterans Asset Protection Trust is that it allows them to put their biggest asset to use, even if it is sold. The Veteran acts as the grantor in this trust and children are the beneficiaries. Under the protection of this trust, proceeds from a home sale would not jeopardize pension eligibility as long as the residence was placed into the trust before the VA application. And should your client need Medicaid more than five years after the trust was established and funded, the sum of money or property set aside to generate income for a named beneficiary would not count as part of the Veteran’s Medicaid application. Therefore, it will not be a countable asset when applying for Medicaid.
The trust also provides all of the same tax benefits of the Medicaid Asset Protection Trust and can certainly be used in the Medicaid environment.
Implications of Medicaid’s 5-Year lookback period
Because this trust can be used in the Medicaid environment, it is important to remember that it is subject to Medicaid’s five-year lookback period. That means your client must create the trust, transfer the assets to fund the trust, and then not require Medicaid benefits for at least five years. After the five years pass, assets are fully protected and will qualify for Medicaid.
As with the other trusts, if your client must apply for Medicaid sooner than five years, he or she can opt to become a private pay patient or go without benefits for the penalty period until the time the five-year period is reached.
When should you recommend the Veterans Asset Protection Trust?
This trust is a good option to consider for just about every Veteran client that is looking for a more conservative trust.
The Parental Protection Trust
The Parental Protection Trust is another option for adding a niche to estate planning services your firm can offer. It provides an alternative to traditional irrevocable asset protection trust planning and enables your clients to divest of assets and give them to their children. Children use those assets to establish the trust for the benefit of their parent — your client — so it is essentially a third-party special needs planning tactic.
By establishing a Parental Protection Trust, a child can donate whatever funds they would like to be set aside for the benefit of the parents. Any assets placed into the trust are preserved until the parent’s death and any remaining assets are distributed back to the children.
It also allows your clients to integrate a life insurance policy in certain cases. Thanks to a concept pioneered by ElderCounsel founder Louis Pierro, children can fund the Parental Protection Trust with enough assets to purchase a life insurance policy with a long-term care rider. In order to take advantage of this, of course, your client must be young and healthy enough to be insurable. It’s important to note that the life insurance policy would have to specifically provide an indemnity benefit, and not a reimbursement benefit for that long-term care benefit. If the parents do meet the requirements for a long-term care rider the indemnity payment comes into the trust.
When should you recommend the Parental Protection Trust?
This is typically an option only for more affluent clients and families that wish to divest of assets and pass them onto their children. It can be even more highly recommended in cases where a client is young and healthy so that he or she may take advantage of the addition of a life insurance policy.
Grantor and Nongrantor Trusts
Grantor and Nongrantor trusts can be confounding for elder law attorneys, particularly new or transitioning attorneys. Essentially, these aren’t really trusts at all, but rather, tax concepts. Therefore, the focus is on how assets are taxed vs. who receives income or assets. Because they are income tax concepts, Grantor and Nongrantor trusts include both ordinary income and capital gains. The good news is that these aren’t terms you’ll need to discuss with your clients, but you will still need to understand the concepts and their potential implications.
In a Grantor Trust, the Grantor typically acts as the trustee, and he or she retains control of the trust. He or she can appoint and change trust beneficiaries, and decide who receives income. Income from the trust is included in the income of the trust owner, rather than the trust or any other person. Grantor Trust status is not an all-or-nothing proposition and can apply to one type of income but not the other. For example it could apply to capital gains and not to ordinary income. It’s also important to not that grantor status can be fractional and therefore apply only to a portion of the trust’s shares.
There are several types of Grantor Trusts, including Retained Interest Trusts (revocable or living trusts), Grantor Retained Annuity Trusts, Qualified Personal Residence Trusts, and Intentionally Defective Grantor Trusts.
Nongrantor Trusts are not taxed to the person that creates or donates assets to the trust (the grantor) and he or she is not treated as the owner of the trust for tax liability purposes. Your client cannot act as a beneficiary or trustee, and relinquishes control of the trust’s assets as well as the right to amend, revoke or terminate the trust. In a Nongrantor Trust, the trust assumes the tax liability for any income derived from its assets.
Why should you recommend a Grantor or Nongrantor Trust for your clients?
Both of these types of trusts can be effective legal strategies for estate planning depending on how your client wants to handle the tax implications and liability of assets. If you’d like to learn more about Grantor Trusts, watch this recorded course, in which we cover the requirements and implications of this type of trust in more detail, including how to cause or avoid Grantor Trust status. And if you’d like to learn more about Nongrantor Trusts, including applicable rules and how to cause or avoid Nongrantor Trust status, watch our recorded course, "What is a Nongrantor Trust?"
The Qualified Disability Trust
This trust is also related to taxes and although it may not be a trust you encounter that often, it’s important to understand the concept of a Qualified Disability Trust. The legal authority to create this type of trust falls under §642(b)(2)(C) of the Internal Revenue Service Code. To qualify as a QDisT, the trust must meet certain criteria:
- It must be irrevocable.
- All beneficiaries (there can be more than one) must be disabled and receiving Supplemental Security Income (SSI) or Social Security Disability Income (SSDI) benefits.
- A Qualified Disability Trust cannot be a grantor trust; the trust must be the taxpaying entity. A self-settled special needs trust can never qualify.
- The trust must be established for the benefit of disabled individuals 65 years of age or younger. The Qualified Distribution Trust does not cease after the beneficiary turns 65, but must be established beforehand.
- According to IRC 642(b)(2)(C)(ii), a trust can still qualify if the corpus of the trust transfers to someone who is not disabled after all disabled beneficiaries are deceased.
There are taxation benefits of this type of trust because it is allowed the same exemption as an individual when filing their tax return. The Tax Cuts and Jobs Act (TCJA) eliminated personal exemptions but it also stated that in any year in which there isn’t a personal exemption, the amount of $4,150 in 2018 (indexed for inflation in following years) shall be considered as the exemption the trust can take. In contrast to the usual exemption afforded to other trusts — which ranges from $100-$300 — it’s easy to see how quickly savings add up.
Furthermore, the income of the Qualified Disability Trust income is not subject to Kiddie Tax, which is a tax on the unearned income of a child. It can also help with non-tax-related goals, such as having assets somewhat available to the beneficiary without the beneficiary losing state or federal public benefits, whereas if the disabled person owned these assets outright, eligibility for government benefits could be jeopardized.
As with all Nongrantor Trusts, the Qualified Disability Trust trust is required to file a tax return, Form 1041, under its own Employer Identification Number (EIN). Any distributions to the beneficiary are taxed on the beneficiary’s own Form 1040 tax return.
When should you recommend a Qualified Disability Trust for your clients?
A Qualified Disability Trust can be one of several beneficial legal strategies for special needs planning within your elder law practice. In order to determine if this type of trust is right for your client you must look at his or her entire case, consider statutory qualification rules, cost considerations and more. When the proper criteria exist, the Qualified Disability Trust can be an effective tool for disabled clients and can provide many benefits.
Understanding your client’s needs
While understanding the different types of trusts is key, making the best estate planning recommendations for your elder law clients depends on understanding each specific client’s needs. This is why every client interaction — from the first client consultation up until a phone consultation 10 years into the relationship — are equally important. When you really know and understand your client you can help them choose the trust that best meets their needs and the needs of their family and loved ones.
It’s also important to capitalize on resources for additional information and support. ElderCounsel membership offers a number of benefits, including access to the ElderDocx intuitive legal document preparation software.
In addition to software, ElderCounsel members benefit from educational tools including document previews, an attorney education library, monthly webinars and recorded courses, and whitepapers. The ElderCounsel community provides access to peer elder law attorneys via an online discussion group, Listserv, and our Ambassador Program. We also offer the tools and insight to help you market your firm so that you can attract and retain elder law clients.
If you’d like to learn more about how ElderCounsel can help your elder law practice thrive, contact us today for more information.