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Using Irrevocable Trusts for Asset Protection Purposes

“Should I have an irrevocable trust to protect my assets?” In the context of the ever-increasing costs of long-term care, this question is being asked of us more frequently. While an irrevocable trust can be used to keep assets from being “counted” for Medicaid qualification purposes, the answer to this question is not simple.

A “revocable” trust is not an asset protection tool. It is an estate planning tool. As an estate planning tool, a revocable trust is attractive to many clients for various reasons. We regularly prepare many estate plans that include a revocable trust as the cornerstone document in the plan.

The creator of any trust is referred to as the “settlor” or “grantor”. The primary reason to have a trust be “revocable” is that there are no restrictions on the settlor’s continued use and spending of the assets that are transferred into the trust. The use of a revocable trust then avoids the probate of the settlor’s estate upon the settlor’s death.

However, because the settlor of a revocable trust has total freedom and control over the assets in the trust, the assets remain “countable” as the settlor’s resources for Medicaid qualification purposes. Creditors can also reach assets in a revocable trust to satisfy the debts of the settlor. On the other hand, a settlor does not have the ability to freely remove assets from an “irrevocable” trust. It is this restriction that protects the assets in the irrevocable trust from being counted as the settlor’s resources.  The assets have become unavailable to the settlor and are thus “protected”.

Assets in an irrevocable trust can be sold by the trustee, but the money received from the sale must stay in the trust or be used to purchase replacement assets that remain titled in the trust. The only thing a settlor (generally) can have the power to receive from an irrevocable trust – and still protect the assets in the trust — is any income produced by the assets in the trust.

It is the restriction prohibiting the removal of assets transferred into an irrevocable trust that causes many clients to decide not to create one. An irrevocable trust can be a powerful asset protection planning tool in the right circumstances. But the loss of access to the value of the assets transferred into the trust must be included in the calculus of whether to use one.

Medicaid’s five-year lookback rule and capital gains tax ramifications (if appreciated property will be transferred into the trust) must also be evaluated when deciding whether to use an irrevocable trust. Gifting assets to a child, and the child then creating an irrevocable trust to own the gifted assets is a strategy sometimes used to minimize the risks posed by Medicaid’s five-year look-back rule. But the use of that strategy can result in capital gains tax implications for appreciated property that would not exist if the settlor still owned the assets at death. The use of an irrevocable trust created by the asset owner(s) that includes a power of appointment can solve capital gains tax issues; but using that approach leaves the transfer(s) to the trust subject to the full risks of the look-back period.

The five-year lookback rule and capital gains tax considerations are two of the larger issues to address when contemplating use of an irrevocable trust. But there are other considerations that may be applicable depending upon a client’s particular circumstances and portfolio contents. All of these complexities mean that thoughtful care should be taken before deciding whether to use an irrevocable trust as part of a planning strategy. Additionally, using an irrevocable trust does not mean that all of the settlor’s assets have to be transferred into the trust. An irrevocable trust can be used to protect some assets, while other assets are left in a revocable trust or simply left titled in the name of the owner.

If you are interested in exploring the concept of using an irrevocable trust as part of an asset planning strategy, the attorneys of Allen Wellman Harvey Keyes Cooley, LLP, can assist you with weighing your options. An irrevocable trust can be a powerful tool to use for asset protection purposes. But any suggestion that that they are the right vehicle for every client for all of their assets is simply not prudent.