Specialty trusts for Medicaid and veterans’ benefits planning

The revocable living trust (RLT) is a very useful and popular estate planning tool, recommended by most estate planning attorneys across the U.S. and used as the central estate planning document by millions of Americans. The primary benefit of the revocable living trust is that assets properly funded into such a trust are protected from the expenses and complexities of probate.

However, what most of our clients don’t realize is that assets in a revocable living trust are NOT protected from lawsuits or from the catastrophic expenses associated with nursing home long-term care.

Medicaid asset protection

But there is a living trust that offers all these protections — a properly drafted irrevocable Income Only Trust (IOT) is a trust that functions very much like an RLT and maintains much of the flexibility of an RLT, but is designed to protect the Settlor’s assets from the expenses and complexities of probate plus lawsuits plus nursing home expenses.

For most Americans, the IOT is the preferable form of asset protection trust because, for purposes of Medicaid eligibility, this type of trust is the only type of self-settled asset protection trust that allows a settlor to retain an interest in the trust while also protecting the assets from being counted by state Medicaid agencies.

Even though the IOT is irrevocable, the settlor retains a high degree of control over the trust assets because the settlor:

• can be the trustee or change the trustee;

• receives all of the trust income;

• gets to live in and use trust real estate;

• can change beneficiaries.

Additionally, as is the case with all non-charitable irrevocable trusts, an IOT can be modified or terminated upon the agreement of all “interested parties” — which are typically the settlor, the trustee, and all beneficiaries.

Medicaid and Veterans Aid

If your client is veteran or spouse of a veteran and needs assistance at home, or in an assisted living facility or nursing home, your client might qualify for the Veterans Aid and Attendance Special Pension Benefit or the Veterans Housebound Special Pension Benefit. This benefit consists of monthly tax-free income intended to help a qualified Veteran pay for the personal care and assistance needed.

In 2014, the Veterans Aid and Attendance benefit can provide:

• $1,732 per month for a qualified veteran;

• $2,054 per month if the veteran is married;

• $1,113 per month for a surviving spouse of a qualified veteran;

• $2,675 per month if both spouses are qualified veterans.

To qualify for the aid & attendance benefit or housebound benefit, your client (or his or her deceased spouse) must have served on active duty for at least 90 days, with at least one day during a period of wartime. A dishonorable discharge eliminates the right to claim benefits. Divorce or remarriage eliminates the right of a surviving spouse to claim benefits. If younger than 65, the veteran must be totally disabled.

If age 65 and older, there is no requirement to prove disability. However, the veteran or spouse must be in need of regular aid and attendance due to: inability of claimant to dress or undress himself or to keep himself ordinarily clean and presentable; frequent need of adjustment of any special prosthetic or orthopedic appliances which by reason of the particular disability cannot be done without aid (this will not include the adjustment of appliances which normal persons would be unable to adjust without aid, such as supports, belts, lacing at the back etc.); inability to feed himself through loss of coordination of upper extremities or through extreme weakness; inability to attend to the wants of nature; or incapacity, physical or mental, which requires care or assistance on a regular basis to protect the claimant from hazards or dangers incident to his or her daily environment.

Unfortunately, the IOT does not protect assets in connection with the Veterans Aid and Attendance Benefit because, for veterans purposes, property that a claimant has some ability to use is includable in the claimant’s countable assets. But there is a special type of veterans trust that protects assets both in connection with Medicaid and the veteran’s aid and attendance benefit.

An irrevocable trust can be made a “grantor trust” for income tax purposes by using one of the grantor trust powers that creates grantor trust status over income. The primary powers used for this purpose are:

(a) the power to receive income – this power is used in the IOT, but can not be used in a Veterans Trust;

(b) the power to substitute assets of equal value – this power can not be used in an IOT or a Veterans Trust as Medicaid and VA might construe this power as having “access” to principal;

(c) the power to change beneficiaries (i.e., a limited Power of Appointment) – this is the one power that can be used in both an IOT and a Veterans Trust.

The vast majority of Veterans who are attempting to get the aid and attendance benefit are middle class Americans who have estates that are not likely to be subject to Federal Estate Tax, so the goal in estate planning for these clients, just as with Medicaid planning clients, is to create a trust that is a grantor trust for both income and estate tax purposes. The power to change beneficiaries will achieve the desired goal of Estate Inclusion for Estate Tax and Capital Gains.

Step-up purposes

Importantly, the settlor can act as trustee of an IOT for Medicaid purposes and as the trustee of veterans trust if desired, but having a trusted family member act as trustee is almost always better from a practical standpoint.

– By Evan H. Farr, CELA. Farr practices estate planning and elder law with the Farr Law Firm in Fairfax.