In the field of estate planning, there are trusts that can be revoked, and others that cannot be dissolved. If you are thinking about the possibility of creating a trust, you would probably feel more comfortable if you knew that you could revoke it if you change your mind. This makes sense on the surface, but there are some very good reasons why an irrevocable trust would be the better choice under some circumstances.
Incidents of Ownership
To gain an understanding of this subject, you have to learn about the concept of incidents of ownership. When a revocable living trust is established, the grantor of the trust can in fact revoke it at any time and take back direct personal possession of the property. The trust creator can also act as the trustee and the beneficiary at first, so the control of the assets is absolute. Because of this arrangement, the grantor is retaining incidents of ownership
Things are entirely different with an irrevocable trust. The grantor of this type of trust surrenders incidents of ownership, because the trust can never be revoked. Generally speaking, the grantor cannot directly access the assets or change the terms of the irrevocable trust. This may sound restricting, but it can actually be a very good thing. Let’s look at a couple of reasons why you may want to utilize an irrevocable trust.
Nursing Home Asset Protection
The majority of senior citizens will need some form of long-term care eventually, and Medicare will not pay for a stay in a nursing home or assisted living community. This is a very big deal, because these facilities are extremely expensive. Medicaid is another government health insurance program, and it will pay for long-term care if you can gain eligibility.
Since the program is intended for people with very limited resources, there is a low asset limit. To qualify for Medicaid to pay for long-term care, you could divest yourself of assets so that you can gain eligibility. One way to do this would be to give direct gifts to your loved ones. You would essentially be giving them their inheritances in advance.
There is another option, and it can also be good for you financially during your elder years. You could convey assets into an irrevocable income-only Medicaid trust. While you would not be able to access any of the principal, you could continue to receive earnings from the assets that are in the trust. If you apply for Medicaid at some point in time, the assets in the trust would not count against you.
You do have to be aware of the five-your look-back period if you are positioning your assets with future Medicaid eligibility in mind. If you give away assets within five years of your application submission, it will be denied, and a penalty will be imposed.
To explain by way of example, let’s say that the state has determined that the average annual cost of nursing home care in your area is $125,000. You gave away $375,000 within this five-year window. The gifts would have paid for three years of nursing home care, so your eligibility would be delayed by three years.
Estate Tax Efficiency
There is a federal estate tax in the United States that can take a heavy toll on your legacy if you have been very successful from a financial standpoint. This tax carries a hefty 40 percent maximum rate. The good news is that there is a relatively high credit or exclusion. This is the amount that can be transferred before the estate tax would come into play. At the time of this writing in 2018, the federal estate tax exclusion is $11.18 million.
A relatively small number of states in the union have state-level estate taxes that sit apart from the federal death levy. We practice in New York and Vermont. Both of these states have state-level estate taxes. Until 2019, the New York state estate tax exclusion is $5.25 million, and the top rate is 16 percent.
At the beginning of 2019, this exclusion will be increased to match the amount of the federal estate tax exclusion that is in place at that time. In Vermont, the state level exclusion is $2.75 million, and the maximum rate is equal to the New York rate.
If you are exposed to estate taxes, you could convey assets into an irrevocable trust. Once you have done this, they would no longer be part of your estate for tax purposes. There are particular types of irrevocable trusts that can facilitate eventual transfers at a tax discount.
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