Long-term-care planning using trusts

More than a few clients who are retired or nearing retirement lie awake at night wondering how they would be able to afford the astronomical expense of long-term care such as a nursing home, which can cost thousands of dollars per month for an untold number of years.

They may wish they had applied for long-term-care insurance when they were healthy enough to pass the medical underwriting standards.

The fallback option for many Americans is Medicaid, a joint federal-state entitlement program, but that requires spending down assets. To be eligible for long-term care through Medicaid, an individual’s “countable” assets must fall below an extremely low ceiling (in most states, no more than $2,000, with special provisions protecting spouses, but some states have higher limits). States vary in terms of which assets are counted, with many exempting a primary residence, for example.

Some clients who want to plan for the use of Medicaid for long-term care may benefit from creating an irrevocable trust, according to Elizabeth Forspan, Esq., who gave a highly rated presentation at the AICPA & CIMA ENGAGE 2023 conference titled “Paying for Long Term Care: Using Trusts for Planning Around Shortfalls in LTC Resources.”

The basic idea behind such planning is this: If clients transfer assets to an irrevocable trust at least five years (in most states) before applying for Medicaid for long-term care, the Medicaid agency, under its rules, will not count those assets in determining whether Medicaid’s asset ceiling is satisfied, said Forspan, a trusts and estates and elder care attorney with Forspan Klear LLP.

But if this planning is done incorrectly, there is a risk the client will not qualify for Medicaid, defeating the objective of creating the irrevocable trust. Plus, “you may have also really blown up their tax plan” and caused them liquidity and other problems, Forspan said.

Some clients interested in Medicaid planning may have asset levels as high as $2 million or more in the New York City area where Forspan practices, she said, much of which may be their primary residence’s value in the region’s elevated real estate market. A nursing home there can cost privately paying patients upwards of $20,000 per month (or about $250,000 per year).

The timing of Medicaid planning

“A question that I get all of the time,” Forspan said in her ENGAGE presentation, “is what’s a good age to start Medicaid planning?” She suggested mid-to-late 60s or early 70s is the right time for clients interested in this type of planning to move assets into a Medicaid asset preservation trust (also called a Medicaid asset protection trust).

The reason this is usually the appropriate age for Medicaid planning has to do with Medicaid’s lookback period, Forspan said. Most states have a five-year lookback for both nursing home care and home care. If any transfer of countable assets was made within the preceding five years of applying for long-term-care Medicaid, there will be a penalty period during which the client will have to use other means to pay for the care. The penalty is measured by the length of time the transferred assets could have paid for care, based on average costs in the state or region.

When clients transfer assets in their mid-to-late 60s or early 70s, statistically speaking, they can still expect to stay healthy long enough to ultimately satisfy the five-year lookback period and avoid a penalty period, Forspan said. The reason for not setting up the irrevocable trust at an earlier age (barring a major health concern) is that “most 60-year-olds don’t want to divest themselves of their assets,” she said.

The advantages of using a trust

Why not advise clients who wish to transfer assets (again, five years in advance) to become eligible for Medicaid to make outright gifts to their children or others?

“I will tell you that 99% of the time or more” a trust is preferable, Forspan said.

The most obvious advantage of a trust is to prevent a child from squandering money given for safekeeping. But beyond that, using a trust can protect the assets from the child’s creditors. And if the child divorces, the money will not end up in the hands of the child’s former spouse. As Forspan put it: “Nobody wants their former daughter-in-law walking around with half of their assets, right?”

Using a trust does not mean that clients should not also make outright transfers of funds to their children for safekeeping. The best approach may be a mixture of both, Forspan noted.

The design of the trust

For clients who decide to create a Medicaid asset preservation trust, “the trust design is really critical,” Forspan said. In drafting the trust, attorneys generally seek to accomplish two things that seem to conflict. On the one hand, “we want the Medicaid agency to say the settlor no longer owns those assets,” which, as Forspan pointed out, is the whole point of creating the irrevocable trust.

But on the other hand, in most cases, “we want the IRS to say the settlor still owns those assets and therefore will receive a basis step-up” at death.

In other words, “how do we create a trust where Medicaid says the assets are not yours; you’ve gifted them,” Forspan said, “but the IRS says ‘no, those assets are still yours’?”

Achieving both seemingly inconsistent objectives is possible, Forspan said. One approach is to give the settlor a limited power of appointment to change the beneficiaries of the irrevocable trust. This action does not affect the gift to the trust for Medicaid purposes but prevents a completed gift from occurring for tax purposes, enabling a basis step-up at death. But each Medicaid agency’s rules and, specifically, its approach to irrevocable trusts must be considered, she said.

In an email exchange, Forspan said that one question she’s been asked a lot lately is whether this planning approach is affected by Rev. Rul. 2023-2, in which the IRS rejected a basis step-up in a situation involving an intentionally defective grantor trust. She said the answer is “no,” explaining that the revenue ruling involved a completed gift, whereas in most Medicaid planning, the “gift” or transfer of assets to the trust is incomplete from a gift tax perspective.

Another benefit of drafting the irrevocable trust with a limited power of appointment to change the beneficiaries is that the trust will be a grantor trust. The grantor will then be responsible to pay the taxes, which is generally desirable because trusts have less favorable, accelerated tax brackets, Forspan said in her ENGAGE presentation.

One asset that clients may wish to put in the irrevocable trust is their home, if it is not a fully exempt asset under the state’s Medicaid rules. For some clients, doing so is “almost a no-brainer,” Forspan said. In the trust instrument, the clients can grant themselves the right to live in the home for the rest of their lives (akin to a life estate). If the trust is drafted properly, the Sec. 121(a) gain exclusion can be preserved too, she said.

But again, if the irrevocable trust is not drafted carefully, it can cause more harm than good, including damaging the clients’ tax plan, creating liquidity problems, and more. Because of this, Medicaid trust planning requires a team that includes an attorney, a financial planner, and a CPA, Forspan said, describing this as “the three-legged stool.”

A video recording of Forspan’s conference presentation, “Paying for Long Term Care: Using Trusts for Planning Around Shortfalls in LTC Resources,” is available to those who bought an all-access pass to AICPA & CIMA ENGAGE 2023. The video can also be purchased.

— Dave Strausfeld, J.D., is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact him at David.Strausfeld@aicpa-cima.com.