Trusts and Medicaid: Protecting Assets

People regularly ask us whether they should use a trust to protect assets in case they go to a nursing home. The answer is, … maybe. If your crystal ball can predict the future, then we can answer that question with certainty (our crystal ball doesn’t work).

Medicaid has rules that apply to any trust you create (called a self-settled trust). The rules apply if you, your spouse or others (named in the statute) who act for you create the trust or if the trust is funded with your assets. Exceptions to this general rule include true third party-trusts (because you didn’t create or fund them), testamentary trusts and properly structured special needs trusts.

If your trust is revocable, then it doesn’t protect anything. Revocable trusts are used for many purposes, such as avoiding probate, but they won’t do you any good if your goal is to protect money or property if you go to a nursing home.

If your trust is irrevocable, then an any circumstances test will be applied. If there are any circumstances, no matter how hypothetical or even unlikely, under which income or principal could be paid to or for the benefit of the applicant, then income and/or principal are deemed available to the full extent it could be paid. If there are no circumstances under which income or principal could be paid to or for the benefit of the applicant, then the transfer penalty rules apply if the trust was funded within the look back period. The any circumstances test has been construed to mean that if anyone, whether acting as trustee, trust protector, beneficiary, or in any other capacity could cause income or principal to be paid to the benefits applicant, then the trust is available. One court stated it this way: “If the grantor of the irrevocable trust leaves open even a “peppercorn” of discretion for the trustee to pay the grantor from the principal of the trust under any circumstance, the entire principal of the trust will be deemed available to the applicant and therefore will be treated as a “countable asset,” making the applicant ineligible for Medicaid benefits.”

In Hegadorn, a trust for the sole benefit of the Community Spouse (see 42 USC 1396p(c)(2)(B)(i)) did not per se violate the any circumstances rule because the spouses were not alter egos. “[A] trust’s payments to “a community spouse does not automatically render the assets held by the trust countable for the purpose of an institutionalized spouse’s initial eligibility determination.” In Hegadorn, the case was remanded to review a supplemental care trust to determine whether it, as remainder beneficiary, might create a set of circumstances where the applicant might receive payments. However, in Daily, a different result was reached where the court foudn that “payments to the spouse benefit the transferring individual.”

Most of the reported cases indicate that a reserved right to live in a home does not violate the any circumstances test with respect to principal if the applicant had a right to income and the applicant is required to pay the expenses associated with the right of use. In these cases, the right to use the property was deemed to be in lieu of receiving income. Although the cases do not directly compare this type of interest to a life estate, the implication is that a beneficiary with a right to use residential property has the same duty to avoid waste or taking action that diminishes value that a life tenant has toward remainermen.

Where the trustee had discretion to make loans to an applicant without adequate security, the trust failed the any circumstances test. In another case, the power to make unsecured loans to any person caused the trust to be available. These cases underscore the difference between trusts prepared by tax lawyers and Elder Law Attorneys because tax planners are only looking at the grantor trust rules in the Internal Revenue Code.

In a case where the trustee had discretion to pay the settlor’s tax obligations, the trust principal was deemed available.

In one case, although the settlor was not a beneficiary, the trust suggested that the trustee should consider her circumstances and suggested that the trustee find a way to help her if needed. Because the trustee had “uncontrolled discretion,” this was deemed to create a circumstance where the trust was available.

A power to substitute trust assets (retained to achieve grantor trust status under the tax code) could create problems, but one court found that where the power is limited to substituting assets for others of equivalent value, any transaction would be “a sale of trust assets to unrelated third parties, followed by a reinvestment of sale proceeds by the trust.”

Although more recent cases, relying on State trust law and the Restatement on Trusts, tend to find that a limited power of appointment does not violate the any circumstances test, some earlier cases found otherwise. They conjectured that an applicant could collude with a potential recipient to make payments in return for exercise of the power.

In sum, if the trust gives anyone discretion to make income or principal available to the benefits applicant, then the trust likely fails the any circumstances test. With that in mind, if you want a Medicaid asset protection trust, then you must be prepared to give away all of your right to income and/or principal. That reality gets us back the original answer to the question of whether to use a trust. The answer is “maybe.”

Recently I met with a family where an irrevocable income trust was established years ago. Ostensibly, the purpose was to protect trust principal in the event the settlors needed nursing home care. As events turned out, they didn’t go to a nursing home; they went assisted living which is private pay in Georgia. The trust principal, assuming the trust was properly administered, was unavailable to help with those expenses. The lesson here is that when we do advance planning, we have to make assumptions. Sometimes those assumptions are correct and sometimes life takes a wrong turn in Albuquerque.