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A Better Partnership


Feb 2014
February 07, 2014

Estate Planning Tip: Key Types of Trusts

The December newsletter on the various types of special needs trusts led me to realize that there is confusion among advisors about special needs trusts and trusts in general.  Here is an overview of the most commonly used types of trusts and their purposes:

Revocable Living Trust: This is the basic estate planning trust that people use to plan for the disposition of their assets while avoiding probate proceedings upon death or disability.  In the past, a husband and wife often would each establish their own revocable living trust for estate tax planning reasons.  With the increase in the estate tax exemption, most people can now safely establish joint trusts.  Upon death, these trusts can break into many different types of sub-trusts, including Credit Shelter Trusts (for estate tax planning), Marital Trusts (to provide for a spouse while insuring that assets eventually pass to children), Testamentary Trusts (to protect assets from a Medicaid spend down if the surviving spouse enters a nursing home), Generation Skipping/Asset Protection Trusts (to protect assets against divorce, creditors and estate taxes for children), and Special Needs Trusts (to protect assets for a disabled child).

Irrevocable Asset Protection Trusts: These are middle class asset protection trusts that allow a person to transfer assets into a format that will provide some degree of protection from creditors and exclude the assets for Medicaid qualification purposes after five years.  Varying degrees of control can be retained over the assets, depending on the client goals, including the right to income from the assets, the right to serve as trustee and the right to change the distribution of the trust upon death through exercise of a power of appointment.  Typically, no right to principal is retained.  Therefore, creditors of the person creating the trust can reach the trust income, if the right to income was retained, but cannot reach the principal.  Because of the retained powers, the trust is taxed to the person creating the trust for income and estate tax purposes.  

Testamentary Trusts:  Testamentary trusts are trusts that are created by the terms of a will.  The Will must be admitted to probate in order for the trust to take effect.  Since most people use revocable living trusts to avoid probate, these trusts have rarely been used in the past.  However, because of a provision in federal Medicaid law, they are sometimes created for the benefit of a surviving spouse.  That provision allows a person to create a trust for the benefit of his or her spouse and have the trust assets excluded for Medicaid qualification purposes, but only if the trust is created under the terms of a will.  The trust must have someone other than the spouse as the trustee and distributions from the trust must be within the sole discretion of the trustee.

Sole Benefit Trust:  This trust allows a person in need of nursing home care to become immediately Medicaid eligible by transferring excess assets to a trust established for the sole benefit of a spouse or disabled person.  No divestment penalty will be applied against the person needing nursing home care and there is no limit on the amount of assets that can be transferred.  The assets will be countable to the spouse or disabled person, however, so care must be taken if that person needs to qualify or maintain eligibility for benefits.  Minimum distributions are required to that person each year.

First Party Special Needs Trust:  This type of trust is also known as a Self-Settled Special Needs Trust or a Medicaid Payback Trust.  It can be used by a disabled person under age 65 to shelter his or her own assets.  The trust allows the disabled person to become immediately eligible for Medicaid and Supplemental Security Income (SSI).  It is authorized by federal law and allows a disabled person to receive benefit from his or her own assets while still qualifying for Medicaid and/or SSI.  Upon the death of the disabled person, any remaining assets in the trust have to first be used to payback Medicaid.  If the assets have been spent on other needs, then Medicaid’s claim will go unsatisfied.  Only a parent, grandparent, guardian or a court can establish such a trust.  The trustee must be someone other than the disabled person

Third Party Special Needs Trust:  A third party special needs trust is usually established by a parent or other close relative of a disabled person by gift during lifetime or upon death through the relative’s estate plan.  Unlike the First Party Special Needs Trust, there is no pay back requirement for Medicaid.  It allows a disabled person to benefit from a gift or inheritance without losing their Medicaid health benefits.  The trust must have someone other than the disabled person serving as trustee and distributions from the trust must be in the sole discretion of the trustee.

Estate Tax Planning Trusts:  An alphabet soup of trusts are commonly used to help reduce estate taxes, including Irrevocable Life Insurance Trusts (ILIT), Grantor Retained Annuity Trusts (GRAT), Qualified Personal Residence Trusts (QPRT) and Intentionally Defective Grantor Trusts (IDGT).  Because of the changes to the estate tax laws, theses trusts would typically be established only by an individual with a net worth in excess of $5 million or a married couple with a net worth in excess of $10 million.

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