We get a lot of client questions about protecting assets from the nursing home. It would be easy for us to sell an irrevocable trust to every prospective client who raises the issue (which, honestly, is a lot of them).
But we don’t. We spend time talking people out of them. Here’s why.
Understanding MA
To understand why we don’t use irrevocable trusts, you first have to understand a little bit about how long term care is paid for in this country.
Everyone who reaches a certain age will receive Social Security and Medicare. The government calls these programs “entitlements,” meaning that all of us are entitled to them because we paid into the system with payroll taxes while we were working.
Medicare will cover short nursing home stays intended for rehab (so, for example, recovery from surgery). But Medicare does not cover long term stays in nursing homes or assisted living. To offer that benefit to everyone, the government would have had to either raise taxes or cut other benefits, and so far it has been unwilling to do so.
That’s not the end of the story, of course. There is a government program that covers long term care. That program goes by a few different names (MA, Medical Assistance, Family Care, Medicaid, and Title 19). (For simplicity, we’ll call it MA.) The government considers MA a public benefits (welfare) program, and it works like food stamps, BadgerCare, and other public benefits programs. To receive MA, you have to apply, and you have to demonstrate need according to the government’s formula. The formula is complicated for married couples where one spouse needs care, but a single person essentially must be out of money to qualify for MA.
To make things more complicated, assisted living facilities are not required to accept MA, and many don’t. Nursing homes do, but can limit how many MA residents they have. So, the government will not force a person who qualifies for MA to go to a specific facility, but as a practical matter the person’s choices will be limited.
A Story About Asset Protection
Over the years, in response to this system, groups of smart lawyers worked out a variety of strategies to allow their clients to qualify for MA and still pass most of their wealth to their kids.
At first, many years ago, this wasn’t very hard. A person who needed care would simply give their assets to their kids, then apply for public benefits. The government would dutifully check to determine if they had any assets. Finding none, the government would pay for their care.
Eventually, our friends in Washington figured out this was happening, and decided to do something about it. That led to the lookback rules. Under those rules, a person would not be eligible for MA if they gave away assets in a certain time period prior to applying. Originally, this “lookback” was 36 months, and the government changed it to five years and strengthened it in other ways in 2006.
This lookback meant that the “easy” strategies had to be replaced with something that allowed gifts much earlier—well before care needs were imminent. Enter the irrevocable trust.
The idea of the irrevocable trust is simple. The trust creator (called the grantor) gives the assets to an irrevocable trust while they are healthy. The trust is a separate, irrevocable entity, meaning the grantor cannot demand the assets back, and is controlled by someone else (typically, a child). If the grantor needs care in the future, they do not own the assets in the trust. The kids keep the trust assets, and the grantor qualifies for MA. Problem solved.
But over time, these trusts became much less useful, for four big reasons.
Big Reason #1: The Rise of IRAs
Today, most people with some wealth now hold a significant portion of that wealth in qualified retirement accounts (IRAs, 401(k)s, etc.). Under federal law, these IRA accounts are personal to the owner and cannot be transferred to a trust.
Let’s suppose John Smith has a $500K IRA account and wants to do an irrevocable trust. John’s first option is to cash out the IRA, take the tax hit, and put the money in the trust. But this could be a massive tax hit if it is all taken in one year. Should John really pay all these taxes now to hopefully qualify for public benefits sometime in the future?
John’s other option is to leave the money outside the trust. But then if John needed care he would need to spend the $500K IRA first, before he could qualify for MA. Realistically, John is never going to spend $500K on care. (See the good news below.) So what is the point of “protecting” other assets?
Big Reason #2: Taxes
Irrevocable trusts are their own entity, meaning they must pay their own taxes. Before 2006, irrevocable trusts could be “income only,” meaning that the income would be paid back to the grantor every year, and the grantor would pay tax on the income. But now in most cases income stays inside the trust. Trusts pay income taxes at much higher brackets than individuals.
Suppose now John Smith has $500K in a brokerage account. He can move that account into his irrevocable trust, but then every time he (or his kids, who control the trust) sells stock, the trust (not him or the kids) pays the taxes. Trusts currently pay income taxes at 37% for income over $10K/yr. Suddenly, John’s (or more accurately, John’s kids’) management of this account has become very tricky. This is not to mention that John has to pay for preparation of that additional tax return every year.
Big Reason #3: Active Retirement
Back in the day, when people retired, they didn’t do a whole lot. Age 65 was old age then. When you retired, you got together with your buddies every once in awhile and played a little cribbage, watched TV, hung out with the grandkids, and lived on social security. If you lived to 75, you did well. The only reason you would really need that nest egg would be for out of home care.
Now, retirees travel the world, buy nice cars and motor homes, and buy second homes and boats. And they live much longer than their parents and grandparents.
This creates the same planning dilemma as with IRAs. If John Smith is 65 and in good health, he has a choice. He can keep enough to be sure he’ll have enough to fund a fun and comfortable retirement. In that case, he probably also kept enough to pay for care, too, and will never qualify for MA.
Or, John can give away enough that he might actually qualify for MA someday. But that might crimp his style a bit—he might worry that he gave away too much, and he might be right, especially since he can’t live off the income of whatever he gave away. Is an irrevocable trust going to make his retirement better? Can he really accurately figure out how much he needs to give away to strike the right balance?
Big Reason #4: The Government is Broke
The government is not really broke. But it does have priorities. Unfortunately, reimbursing nursing homes and assisted living facilities for what it costs to take care of our elders is pretty far down the government’s priority list. This lack of MA funding is a problem that has gotten consistently worse over the years, as the cost of care has risen and the government’s MA reimbursement rates have not.
What does this mean for people considering irrevocable trusts?
Most long term care provided today is provided by assisted living facilities, not nursing homes. Remember, assisted living facilities are not required to accept MA. And increasingly, they don’t. Many facilities have concluded that they have to choose between providing the level of care they believe is appropriate, and accepting MA payments that are well short of that. Every year, more make that choice.
That leaves people with a choice. Again, John Smith can pay for his own care, and have the ability to choose a nice assisted living place if it comes to that. Or he can give it all away, and bet that the government will provide good care in 20 or 30 years.
I wouldn’t tell my parents or grandparents to take that bet. So I don’t tell John to either.
Now, the Good News
The good news is, for people with some wealth, assisted living is not the financial drain people think. I’ve had clients come in with $2M in various assets, and ask for a second opinion because they were advised to do an irrevocable trust to protect their assets from the nursing home.
Let’s run the numbers on that. Suppose our friend John Smith doesn’t even have $2M. Let’s say John has $500K in a retirement account and a house worth $300K. He had a good job and has a small pension, so his social security and pension income is $2500/mo. He needs assisted living, so his kids help him sell the house and move. His house proceeds and IRA are invested conservatively, with a 5% rate of return. That means his income from $800K of investments is $40K/year, and his social security and pension are $30K/year, for a total of $70K per year. Assisted living is $6K/month, or $72,000/yr. John is eating into his kids’ inheritance to the tune of $2K/yr.
Now assume John has $2M. Why would John need or want to structure his estate plan around qualifying for MA?
What We Do Recommend
We come back to the idea that an inheritance should be just that—passing on whatever happens to be left when someone dies. Or, for those who can afford to and want to make a gift now, just make a gift now. But an estate plan should not be an asset protection plan. It should make sure wealth will transfer as intended, avoid probate if it makes sense to do so (it often will) and ensure proper advance planning for health and financial decision making is in place.
Sometimes, simpler really is better.
Ready to get started on an estate plan? Have questions about the right option? Call today or schedule online for a free consultation.