Seniors who want to pass on assets during their lifetimes may be tempted to gift assets to their children or family members, outright, free of trust. However, establishing an irrevocable trust through which gifts are made for the benefit of their children can better protect those gifts from loss or dissipation during the Seniors lifetime in the event of needed family support.
A trust is a legal entity under which one person — the “trustee” — holds legal title to property for the benefit of others — the “beneficiaries” who hold equitable title. The trustee must follow the rules provided in the trust instrument. An “irrevocable” trust cannot be changed after it has been created. In many cases, trust income is payable to the “grantor” (the person who funds the trust, also commonly known as the “trustmaker” or “settlor”) for life, but not the principal. Upon the death of the grantor, the trustee makes final distribution of the remaining trust principal to the beneficiaries, usually the children. This way, the funds in the trust are protected during the life of the grantor from creditors while allowing the grantor to retain the income from the assets for living expenses.
Gifting assets outright can have unintended consequences, whereas establishing an irrevocable trust in which to make gifts has many advantages instead:
- Income. Putting assets in a trust means the grantor can receive income from the assets to continue to pay for living expenses. Depending on how the trust is set up, the grantor can receive regular income payments or the trustee could have discretion to make payments.
- Control. The grantor can retain certain rights over trust assets and personnel. For instance, the grantor chooses the trustees and can retain the power to remove and appoint new trustees. The grantor establishes the rules of the trust from the beginning. The grantor can also retain the right to appoint or change beneficiaries by designation in the grantor’s will.
- Asset protection from creditors. If money is given outright to a family member directly, that money could be lost to the recipient’s carelessness, creditors, or divorce. Gifting money to an irrevocable will help protect those assets from claims of creditors.
- Taxes. Trusts can protect the beneficiaries from capital gain taxes whereas gifting assets outright can create significant potential tax liabilities. For instance, assets that have gone up in value will receive a “step-up” in basis on the death of the grantor, which means the beneficiaries will pay less or no capital gains taxes. Assets that are gifted do not receive a “step-up.”
- Medicaid. If it is anticipated the long-term care benefits will be needed in the future, then it is important to plan ahead. If money is gifted outright or to an irrevocable trust within five years (the “look-back period”) of applying for Medicaid, the grantor will face a period of ineligibility for Medicaid benefits. The actual period of ineligibility will depend on the amount gifted or transferred to the trust. However, after five years, the gifted money is protected and not counted against the applicant. Putting assets in a trust is an excellent way to plan for Medicaid in the future.