Irrevocable Income Only Trusts: A Valuable Medicaid Planning Tool

The Irrevocable Income Only Trust is an important planning tool

It is no secret that the high cost of long term care can be ruinous. Everything you worked for — lifetime savings, even your house and retirement accounts — can all be wiped out in a matter of months to a few years. That is why advance planning, including Medicaid planning, is so important. It is critical for most families that a loved one needing long term care qualifies for Medicaid assistance.

Among the planning strategies used to qualify for Medicaid, one of the most important is transferring assets into an Irrevocable Income Only Trust (“IIOT”). The purposes of the IIOT include (1) to preserve a source of income, (2) to shield and manage assets, (3) to ensure Medicaid eligibility, and (4) to avoid the costs and time associated with probate. IIOTs allow individuals to transfer their assets into a trust as protection in lieu of making outright transfers to their children. Under the terms of an IIOT, the transferor (“grantor”) will receive all of the income produced by the assets in the trust for the grantor’s lifetime. By transferring assets into an IIOT, the grantor will still reserve some control and retain some interest in the transferred assets — advantages that are not available when transfers are made outright to individuals. If the grantor places the grantor’s home into the trust, then the trust agreement can specifically provide for the grantor to continue to reside in the home for the grantor’s lifetime. Because IIOTs are irrevocable, the grantor cannot revoke the trust and reacquire the assets; therefore, the assets are deemed unavailable (and, therefore, not countable) for Medicaid eligibility purposes.

The IIOT can be used to qualify for Medicaid

Under current law, Community Medicaid (i.e., the kind applicable for care at home or at many Assisted Living Facilities) may be available within a couple of months after the assets are transferred into a trust. Institutional Medicaid (i.e., the kind applicable for care at a Nursing Home) would be available after the look-back period expires. The look-back period is the time window within which Medicaid can look to see if assets have been transferred. It is also the period prior to the Medicaid application during which Medicaid will penalize an applicant for transfers within such period. Under current law, the look-back period is now five (5) years.

Assets transferred into a trust more than five years prior to the filing of a Medicaid application will not impact Medicaid eligibility. If, however, a person who set up such a trust ends up needing Nursing Home care before five years elapse, a penalty period would be assessed and some other planning technique would likely have to be employed. If a penalty is imposed because of a transfer to an individual or a trust within five years of a Medicaid application, the period of ineligibility begins when the individual enters a nursing home and is otherwise eligible for Medicaid.

The IIOT can save taxes

IIOTs also offer tax advantages. The grantor is treated as the owner of the trust for income tax purposes. This is valuable because the trust’s income tax rates are usually higher than the grantor’s income tax rates. Additionally, the IIOT can be drafted to include a special power of appointment for the limited purpose of including the trust assets in the grantor’s estate for estate tax purposes. A special power of appointment will also permit a grantor to change his or her beneficiaries. Upon the grantor’s death, the trust assets obtain a “step-up” in value. This means that when the assets are distributed to the grantor’s chosen beneficiaries, the beneficiaries’ bases in the assets for income tax purposes will be the value of the assets as of the grantor’s date of death. As a result, the beneficiaries will avoid any capital gains taxes on the appreciation of the trust assets between the date of acquisition and the grantor’s death if the property is sold after the grantor’s death.

An Irrevocable Income Only Trust can be a valuable tool. It is complex and has many potential pitfalls, so a knowledgeable Elder Law attorney must be consulted.