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INCOME ONLY TRUSTS: HAVING YOUR CAKE AND EATING IT TOO

INCOME ONLY TRUSTS:

HAVING YOUR CAKE AND EATING IT TOO

Recently a healthy single woman came to my office with the following demand: “Protect my money in case I ever enter a nursing home, make sure my children do not pay any capital gains tax on the appreciation of the assets, and protect my dignity and self-respect so that I do not have to go my children and ask for money every time I need it.”

The woman’s assets included a home which she and her late husband had bought over thirty years ago for $45,000.00 and is now worth approximately $500,000.00. She also has stocks and bonds in the amount of $600,000.00 which were purchased for $80,000.00. I proceeded to enumerate the three options available to her and the consequences of each.

WAIT & SEE” APPROACH

This first option is also known as the “do nothing” alternative. Here, the client’s hope is that she will never need long term care. If it is eventually required, she will do something about it “when the times comes.” This usually results in the senior citizen spending all of her hard-earned assets on nursing home care. Clients and family members lose greatly and are often left with nothing, while the nursing homes are the big winners.

GO ALL OUT” APPROACH

This second option is where the client transfers all of her assets to her children, without considering capital gains tax and nursing home penalty periods. The children now own these largely appreciated assets, but upon any sale, will suffer a 20% tax hit, in the amount of $195,000.00.

Furthermore, several risks are associated with an outright transfer to children. If the children were to divorce or declare bankruptcy, the client’s money would be used to satisfy the claims of the children’s creditors. Additionally, if the client needed nursing home care immediately, that money may not be available to her, since it now legally belongs to her children. Here the client certainly loses her dignity by asking her children for money as she needs it.

INCOME ONLY TRUST

The third strategy is the course of action the client selected. Income Only Trusts provide a wonderful planning opportunity for both single and married couples who wish to protect their appreciated assets from the nursing home, while at the same time retain control over the income.

Clients who wish to protect their hard earned assets from future nursing home care usually list several factors why they decide to create a trust rather than transfer the assets to children outright. Control is one of the top reasons cited by clients. By transferring the assets to an Income Only Trust, as opposed to an outright transfer to children, the client has more control over the assets, since income is being paid directly to the grantor, rather than to the children. The client feels a greater sense of independence because of this direct payment.

In order to ensure that the assets in the trust are protected from the nursing home, the trust must be irrevocable. The grantor retains the right to receive income but the principal can not be accessed. For Medicaid planning purposes, the five year lookback period begins when assets are transferred into the trust. When assets are transferred from this trust to third parties, no lookback period is imposed because the penalty had been imposed when assets were placed into the trust.

Another reason not to transfer assets directly to children is to avoid some potential risks. If the child has creditors, gets divorced or has certain types of bad habits (gambling, drug addiction, alcoholism, and the like), the assets in the child’s hands may be squandered and will no longer be available to the parent. These risks are not found when creating an Income Only Trust, because the assets only belong to the Trust and not the child, and can’t be attached by the child’s creditors or divorcing spouse, or squandered due to the child’s bad habits.

Tax implications also warrant the use of an Income Only Trust. Since the income flows back to the grantor, the parent will be taxed on the income at the parent’s lower tax rate. Furthermore, if appreciated real estate is placed in the trust, the $500,000.00 exclusion from capital gains tax on the sale of the principal residence is preserved if sold by the trust; it is lost if the house is transferred directly to child who then sell it. From a capital gains tax perspective, the appreciated assets placed into this trust would be included in the client’s estate upon her death. Thus, the children will receive a step-up in basis and avoid paying significant capital gains taxes.

Income Only Trusts can be used in crisis planning but are even better in situations where it does not appear that Medicaid will be needed for a considerable period of time. The Deficit Reduction Act of 2005, signed February 8, 2006 created a five year lookback period for nursing home Medicaid eligibility for both transfers to individuals and to trusts. As a result of this level playing field, many clients have chosen to establish an Income Only Trust, if it is anticipated that Medicaid nursing home will not be required for five years, or if the Medicaid penalty period is less that the look back period.

The sole pitfall using this trust is that the State may seek to recover against the principal, to the extent of payments made by Medicaid on the grantor’s or spouse’s behalf. To prevent this from happening, the trust must terminate before the grantor or spouse applies for Medicaid. Distributing the principal to the beneficiaries during the grantor’s or spouse’s lifetime will not create a penalty as the gift was made when the trust was created. Distributing the income to the beneficiaries during the grantor’s or spouse’s lifetime will create a penalty but only on the income that is foreclosed to the grantor or spouse.

In summary, a properly drafted Income Only Trust is a marvelous planning technique that is easier for clients to accept than outright transfers to children. By properly drafting an Income Only Trust, I can ensure that your money will be protected from the nursing home, your children will not pay significant capital gains tax on the appreciation of the assets, and your dignity and self-respect will be preserved. This way you and your family members are the big winners!

PROTECT YOUR IRA’s FROM CREDITORS, PREDATORS AND NURSING HOMES

PROTECT YOUR IRA’s FROM CREDITORS,

PREDATORS AND NURSING HOMES

 

On June 12, 2014 the United States Supreme Court issued a unanimous decision holding that an inherited IRA passing to a non-spouse beneficiary is not a “retirement fund” and thus does not provide creditor protection. The case focused on Hedi Heffron-Clark, who inherited an IRA worth about $300,000 when her mother died in 2001. In October 2010 Hedi filed for bankruptcy protection. In Clark v. Rameker, the Supreme Court ruled that inherited IRA’s do not enjoy the same protection as traditional IRA’s and are not considered “retirement funds”. Therefore, she could not shield these funds from her creditors.  This decision will have a monumental impact on how the legal and financial communities plan with IRA’s going forward, as individuals who inherit IRA’s are now exposing these assets to their creditors and predators.

The court looked at a three prong test in determining whether an inherited IRA is a retirement fund or not. With respect to an inherited IRA, (1) one can no longer contribute to it, (2) the owner of the inherited IRA must withdraw the funds no matter how far they are from retirement, and (3) the owner of the inherited IRA can withdraw any amount “without penalty” at anytime. Based on these three factors, the Court concluded that an inherited IRA significantly differs from a traditional IRA and is therefore not a “retirement fund”. Thus, it can be invaded by the beneficiaries creditors.

From a nursing home perspective, it is well settled Medicaid law that an IRA is an absolute available resource for either the Medicaid applicant or spouse. Assume you own an IRA worth $100,000, Medicaid says that account must be used to pay for your care. The New Jersey Supreme Court unanimously held that way back in 1998. In Mistrick v Division of Medical Assistance and Health Services, the court held that when calculating an institutionalized spouse’s eligibility for Medicaid benefits to cover nursing home care, a healthy spouse’s IRA must be invaded to pay for the institutionalized spouse’s nursing home costs.

The case involved Sophie Mistrick, who entered a New Jersey nursing home in 1994. At the time of her admission, Joseph Mistrick maintained an IRA account in his name alone worth $150,000, the principal residence, and cash totaling $50,000. The couple began the process of “spending down” their liquid assets of $50,000 in order to qualify for Medicaid. The money in Joseph’s IRA, however, was not spent down, but remained untouched. The court ruled that his IRA was fully available to pay for his wife’s care. Incidentally, had the IRA been converted to an immediate annuity, the entire amount would have been protected.

 

INHERITING AN IRA

If a married individual with an IRA dies, the surviving spouse has three options.

(1) Take the IRA and create a new IRA in his/her name;

(2) Roll it over into an existing IRA; or

(3) Leave it in the name of the deceased spouse. A surviving spouse would do this when his/her life expectancy is shorter than that of the deceased spouse. By leaving it in the name of deceased spouse, there is a longer stretch of time to make distributions.

As the Supreme Court made clear, when a non-spouse inherits an IRA, it is no longer a protected asset. Therefore, when a child inherits an IRA from a parent, he or she is required to immediately take distributions based on the child’s life expectancy, not the parents. Since there is a longer stretch involved, the required minimum distribution will be smaller.

The major negative of leaving an IRA to a child is that the child could take the maximum amount in the IRA if he or she wanted. That would trigger a huge income tax. Although the stretch reduces the minimum, it does not prevent the child from taking the maximum. The solution to this issue and to protect it from creditors is to direct the IRA into an INHERITED IRA TRUST.

 

IRA OWNED BY TRUST AFTER DEATH OF PLAN OWNER

To protect against the issues outlined above, the solution is for a trust to own the inherited IRA upon the death of the IRA owner. If the trust is a “standard” trust, it must liquidate the IRA within 5 years of the plan owner’s death. If, however, the trust meets the four conditions to qualify it as a “see through” trust, then the IRS will not look at the trust as the owner or beneficiary of the IRA. Instead, it will look through the trust and determine who the beneficiaries are within the trust and use those beneficiaries in the trust as the beneficiaries of the IRA for Required Minimum Distribution (RMD) calculation purposes.

 

The four criteria are as follows:

1) The trust must be irrevocable as of death;

2) The trust must be valid under state law;

3) The trust must have identifiable human beneficiaries (i.e. no charities since it is a non-human entity and if there is any condition in which the charity could be named as an ultimate beneficiary of the IRA, it triggers the standard trust, and hence the 5 year payout).

4) The trustee must provide a copy of trust to plan administrator or custodian when plan is created and when plan owner is alive.

 

The trustees of the inherited IRA trust can either accumulate the RMD’s or distribute them to the beneficiaries. In a conduit trust, whatever comes into the trust must go out within the same tax year. Thus, the RMD’s will be paid to the trust (the owner of the IRA) and the trust subsequently passes the RMD’s on to the beneficiaries of the trust. For calculation of taxes, the IRS looks inside the trust to see who the oldest beneficiary in the trust is (the measuring life for RMD’s calculation purposes) but for purposes of distribution the trust pays it to all beneficiaries of the trust. Thus in a conduit trust, the trust distributes the RMD’s to the recipients and they pay the tax, not the trust.

By contrast, there are times when it is best to pay the RMD’s to the trust and not pay it to the beneficiary of the trust. In an accumulation trust setting, if the beneficiary is a spendthrift or on Medicaid, any distribution they receive is potentially lost to creditors. Thus it may be better to accumulate income if beneficiaries are subject to creditors. If so, the Trust now controls what happens with the RMD payment. If the trust retains the RMD’s, it pays the income tax. Although the income tax rates for trusts are more compressed compared to individual rates, most client would rather pay the tax than see the beneficiary’s creditors attach to the RMD’s. In an accumulation trust there is no requirement to accumulate, it is only optional. If a trustee wanted to distribute RMD’s like a conduit trust, he may.

 

WHOSE AGE DETERMINES THE STRETCH?

When you die and leave the IRA to either a trust or a non-spouse beneficiary, it is at that point that the stretch for RMD purposes is determined. It is the only stretch you will ever get out of your IRA forever. So make it count. Whether leaving it to kids or a trust, the IRS looks through the trust and sees all the beneficiaries. The measuring life that they will use for RMD purposes is the oldest beneficiary. Why? The older the beneficiary, the shorter the measure life; the quicker the money is removed from IRA and the sooner the IRS gets the tax revenue.

How do you know who the oldest beneficiary is? It depends on who you name. Below is a sample of beneficiary designations and the corresponding measuring life.

 

Beneficiary Designation                                            Measuring Life

1) “My Estate”                                                                     5 year payout rule

2) “My children”                                                                Oldest child

3) “My trust”                                                                      Oldest beneficiary in trust

4) “The trustee under Article 5 of my trust

f/b/o my children”                                               Oldest Child

5) “1/5 to each trustee of the separate shares

under Article 5 of my trust                                            Each child gets their own separate measuring life

            

DISCLAIMERS

            Using layered planning and combining it with disclaimers provides clients with tremendous flexibility to protect their assets. In fact, no decision must be made with regard to the IRA until 9 months after the plan owner dies, the deadline by which a disclaimer must be filed.

With layered funding the client is provided with the best of both worlds, individual ownership and trust ownership. Suppose the initial beneficiary of the IRA is the trust. Further suppose the initial beneficiary within the trust is a trust set up for a spouse. The spouse would be the measuring life for RMD payout. Remember that you only get one stretch, the age of the spouse. But the spouse can disclaim her right to any IRA proceeds in the spousal trust. Thus, the contingent beneficiary would be the family trust, if established, and we look to see who the oldest beneficiary is in that class, presumably a child. If the trustee of the family trust disclaims, the beneficiary would be the residuary trust.

            Planning with IRA’s is full of pitfalls from an income tax, Medicaid and estate tax perspective. To best protect your IRA and other assets it is critical that you work with an attorney well versed in this area.

 

HOW MEDICAID CAN COVER NURSING HOME CARE COSTS IN NEWJERSEY

HOW MEDICAID CAN COVER NURSING HOME

CARE COSTS IN NEWJERSEY

By: BENJAMIN D. ECKMAN, ESQ.

Elder Law Attorney

The cost of a stay in a New Jersey nursing home can run anywhere between $90,000.00 and $110,000.00 per year. The primary payer for this is Medicaid. Medicaid, unlike Medicare is a welfare program, which covers the medical needs of New Jersey residents over 65, blind or disabled. The Medicaid program is jointly funded by both the federal and state governments. In New Jersey, the Medicaid Only program is administered at the state level by the Division of Medical Assistance and Health Services of the Department of Human Services. At the local level, the County Welfare Board administers the program.

In order to qualify for the Medicaid Only Program, certain income and resource tests must be met. With respect to the income test, all sources are considered. In order to be eligible for Medicaid Only, one’s gross monthly income can not exceed $2130.00. Certain items, however, are excluded, namely proceeds from the sale of a resource, certain insurance reimbursements, the value of social services, the value of food stamps, loans, and tax refunds. For those with income over the cap, Medically Need may apply.

With respect to the resource test, an applicant may retain only $2000.00 in “available” liquid assets. All assets are “available” except for those that are specifically excluded. A partial list of certain excluded assets include the following: home, automobile, wedding rings and engagement rings, life insurance if the total face value does not exceed $1500.00, or if the insurance is term insurance; burial spaces and burial funds; and certain types of annuities.

If the Medicaid applicant is married, a snapshot is taken of the couple’s countable assets as of the first day of the first month that the spouse was institutionalized. The resources of a couple are pooled together regardless of how the assets are titled. In order to protect the spouse who remains in the community, that person is entitled to a Community Spouse Resource Allowance (CSRA). For 2013, the CSRA is one half of the value of the combined assets with a ceiling of $115,920.00 and a floor of $23,184.00. In a further effort to prevent spousal impoverishment, the community spouse is also entitled to a Minimum Monthly Maintenance Needs Allowance (MMMNA), which is presently $1891.25 with a maximum of $2898.00 a month.

In order to spend down the resources to the $2000.00 level, the Medicaid applicant may have made certain transfers in the past. If the transfers were made and the applicant received fair market value in return, no transfer penalty exists. But if the transfers were made within 60 months prior to the time the applicant is both institutionalized and applies for Medicaid, and the Medicaid applicant received less than fair market value, then Medicaid will compute a penalty period. The penalty period, which starts only when the applicant is otherwise eligible, is imposed based on the uncompensated value of a non-excludable resource that was transferred, divided by the average private nursing home rate set by the State, presently $7787.00 a month.

There are assets, however that may be transferred and no penalty period results, even though the transfer was made for less than fair market value. Assets may be transferred without penalty to the following persons: the community spouse prior to institutionalization, so long as the resource was not subsequently transferred; and a child who is blind and totally and permanently disabled.

With regard to the transfer of a principal residence, such transfer can be achieved without penalty so long as it was given to either: the community spouse; a child under 21; a blind or totally disabled child regardless of age; a sibling who already had an equity interest in the home prior to the transfer, and who was residing in the home for at least one year immediately prior to institutionalization; a son or daughter who lived in the home for a period of at least two years immediately prior to institutionalization, and who has provided care to the parent, which permitted the individual to reside at home rather than in an institution or facility. Such care must have exceeded normal personal support activities and must have been essential to the health and safety of the individual and consisted of such activities as supervision of medication, monitoring of nutritional status, and ensuring the safety of the individual. If none of the above lives in the home, the home may lose its exemption as the principal residence after the owner has been institutionalized for more then six months.

States are now mandated to recover from the estate of Medicaid recipients, all medical expenditures and outlays paid by Medicaid.New Jerseywill seek estate recovery from the estate of a deceased Medicaid recipient for all monies expended by the Medicaid program on behalf of the recipient. Without the proper planning, it is likely that your hard earned money will pass to the nursing home, not your family members. The concepts addressed above are by no means exhaustive in nature. The Medicaid laws are quite complex and are constantly under Federal, State and County review. Therefore, it is important that you choose a law firm that is both qualified and experienced in Medicaid Planning and Asset Protection.