Medicaid Asset Protection: What Works and What Does Not

By Evan Farr, Certified Elder Law Attorney

This article was posted by ElderLaw Answers
 

Much confusion abounds in the world of asset protection trusts, including the false belief by many elder law, estate planning, and asset protection attorneys that self-settled Offshore Asset Protection Trusts and/or Domestic Asset Protection Trusts are helpful in connection with Medicaid asset protection planning.  In fact, these trusts are useless when it comes to the world of Medicaid asset protection planning.

“Self-Settled Trust” Defined
The term “self-settled asset protection trust” refers to a very specific type of “self-settled,” i.e., an irrevocable asset protection trust where the settlor is allowed to receive distributions of both income and principal. Such trusts have historically been prohibited in the United States.

This prohibition is seen in both the Restatement of Trusts, Second, and the Uniform Trust Code.  Section 156 of the Restatement of Trusts, Second, states the traditional rule as follows:  “(1) Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest. (2) Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit.”

Section 505(a)(2) of the Uniform Trust Code states that “with respect to an irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.”

Offshore Asset Protection Trusts
The demand for self-settled asset protection trusts (i.e., irrevocable asset protection trusts where the settlor is allowed to receive distributions of both income and principal) and the refusal of anyU.S.jurisdiction to recognize them led to the development of a prosperous Offshore Asset Protection Trust industry by the mid-1980s.  Offshore Asset Protection Trusts make it nearly impossible for general U.S.creditors to reach the underlying assets because the trusts are not subject to the jurisdiction of the States. Thus, in order to enforce the judgment, the creditor must theoretically file suit in the offshore jurisdiction and then try the case in the foreign jurisdiction. Foreign law will apply and the creditor and witnesses must travel across the globe to try the case.

Domestic Asset Protection Trusts
The Domestic Asset Protection Trust (DAPT) is a spin-off of the Offshore Asset Protection Trust. DAPTs were first introduced in theUnited Statesin 1997 as an effort to retain in theU.S.some of the wealth that had been steadily moving into Offshore Asset Protection Trusts. Alaska and Delaware were the first to offer DAPTs. Since then, eleven other states have enacted DAPT legislation: Colorado, Hawaii, Missouri, Nevada, New Hampshire, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah and Wyoming. 

Subject to certain exceptions that vary from one DAPT state to another, most creditors cannot reach property in a DAPT unless that property was fraudulently transferred to the trustee. Most important, for elder law attorneys, however, is the fact that the term “most creditors” does not include Medicaid.

On the contrary, the biggest limitation of both Offshore and Domestic Asset Protection Trusts, which makes them essentially useless for a client who desires complete asset protection, is that these trusts allow the settlor to have access to principal and are therefore absolutely ineffective for Medicaid asset protection purposes because, under federal Medicaid law and under the Medicaid laws of every state, if the Medicaid applicant or the spouse of the Medicaid applicant has access to principal, the assets in the trust will be deemed “countable” for Medicaid purposes.

The Asset Protection Trust that Works for Medicaid and General Asset Protection
Only an irrevocable trust that puts 100 percent of the principal beyond the reach of the settlor is effective for both Medicaid asset protection and general asset protection. This can be a trust designed so that the settlor has no direct access to income or principal or, if the settlor wishes to retain use of at least the income from the trust, it can be designed an Income-Only Trust (IOT), which allows the settlor to receive all ordinary income from the trust, but no direct access to principal.  Based on the author’s research, IOTs work in all 50 states for general asset protection because of the general common law as seen in both the Restatement of Trusts, Second, and the Uniform Trust Code.

IOTs work for Medicaid asset protection because of OBRA ’93 and two ensuing clarification letters from HCFA (now CMS) – one dated 12-23-1993 (the Richardson letter), and one dated 2-25-1998 (the Streimer letter), which together made clear that:  “[t]ransfers to an irrevocable trust with retained income only interests are considered available only to the extent of the income earned”;  and “transfer of those assets to or for the benefit of someone other than the beneficiary does not incur a separate transfer penalty.”  Based on the author’s research, the only two states where the IOT does not work for Medicaid asset protection are Connecticut and Minnesota, both of which have “trust buster” statutes that effectively nullify the Medicaid asset protection features of an IOT.

For more information about the benefits and flexibility of IOTs, and how to properly draft IOTs, visit the author’s Web site at http://www.LivingTrustPlus.com or order the ALI-ABA publication Planning and Defending Asset-Protection Trusts (2009) at http://www.ali-aba.org/bk64, in which the author’s chapter Asset Protection for the Middle Class:  Income-Only Trusts & Medicaid Asset Protection provides a detailed treatise on the topic.

If you are interested in learning more about the Living Trust Plus™ from the Author's Firm's website, simply connect via Facebook by clicking the button below:

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Estate Planning Attorneys Warn About Matching Beneficiaries to Those Named in Your Will or Trust

As an estate planning attorney in Virginia, I have unfortunately seen many circumstances where a person goes through the time and expense of having an estate plan done, only to fail to update their beneficiaries on their financial or retirement accounts before they pass away.

An example of this would be Mary naming her brother Bill as the beneficiary of her life insurance policy in her trust, but at the time of her death, she had a different beneficiary named on the policy itself.

Just as life changes, so do your relationships, which can affect who you want to receive your assets --especially if you do not have children. Changing the beneficiary on assets such as bank accounts or life insurance policies is not uncommon, but you must remember to make sure that your will or trust reflects that change also.

Keeping your estate planning documents and beneficiaries up-to-date and coordinated is a quick and painless way to prevent legal headaches from occurring after you are gone.

Having two different named beneficiaries on two different documents can result in a lengthy and costly process to fix it – especially if each named person believes that they should be the one to inherit the asset.

The best way to avoid problems like this is to have a lawyer who focuses on wills and trusts handle every aspect of your estate.

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Easy way to explain (or understand) the cons of Probate

 Why Most People Want to Avoid Probate

First, it requires frustrating intrusion by the court, lawyers, and the public into a very emotional, private, family time. A judge may have to determine who is a legitimate creditor, and may have to rule on distributions to children and other beneficiaries. Your estate may have to hire a lawyer to shepherd the executor through the legal maze.

Second, all of your affairs will become public knowledge. The contents of your will would be on file in the courthouse, for all to read and wills are read. They are read by salesmen, by newspaper reporters, and by the morbidly curious, all seeking in one way or another to take advantage of the publicity required by the probate process.

Third, probate takes time. Unless your executor is absolutely certain that there are no debts owed by the estate (a rare occurrence, since almost everyone leaves some small debts behind) and is to accept personal responsibility for your debts, the Virginia probate law mandates that your assets not be distributed for one year after you die, to allow creditors time to petition the court for full payment. Any assets distributed before that time come with a heavy cost for your executor he or she is personally liable for the repayment of all of this amount, even if the beneficiaries to whom distribution is made have already spent the amount distributed. Thus, your executor will likely be very hesitant to distribute before all debts and taxes are paid. The court, not your family, will supervise and authorize the settling of all debts and the payment of inheritances, in its time and with its delays.

Fourth, on a national average the probate process takes from five to eight percent of your family estate out of the hands of your beneficiaries and gives it to the courts and other outside individuals. In Virginia, this is usually lower, but can also be higher in the event of unusual circumstances, such as a will contest. Planning with a trust can save the average American family about $30,000 in probate fees, attorney fees, and court costs alone, according to a national study by the AARP. The up front cost of a trust is only slightly higher than just a will, but the savings in the end can make the initial expense more than worthwhile.

Fifth, if you are not competent at any time before your death, the trustee of your living trust can serve as the caretaker of your property. This can avoid the expensive and embarrassing public guardianship/conservatorship proceeding, where your children have to prove that you are not able to manage your own affairs. A living trust combined with a power of attorney can provide the most complete protection available. Evan H. Farr on Google +