Clients are often and understandably confused about the differences between irrevocable trusts and revocable living trusts, and the consequences they each have for asset protection, estate planning and taxes.
Those who advocate living trusts commonly lead people to believe that these trusts will reduce estate taxes and protect one’s assets in the event long-term health care is needed. While living trusts serve the purpose of avoiding probate, they do not protect your assets. Since you maintain control over the assets in your revocable trust, they are still considered available to pay for your health care needs. Similarly, unless a living trust creates certain types of irrevocable subtrusts, it does not reduce one’s taxable estate since the person creating the trust maintains complete control. Notwithstanding the foregoing, living trusts are extremely beneficial in certain instances, where, for example, the person creating the trust has disabled heirs, in situations where it is believed that some heirs are likely to protest the estate plan, or where the heirs are distant relatives. In these situations, having a living trust will have the effect of avoiding a more lengthy and costly probate process. Additionally, if one owns real property in another state(s), establishing a living trust will mean that your heirs won’t have to go through a second probate in the other state(s).
The only way to protect assets from long-term health care costs and creditors is to transfer assets to family members or to an irrevocable trust. Putting one’s home into such a trust can be quite beneficial. In most instances, one does not rely on one’s home as an income source with which to pay bills; therefore, transferring ownership to an irrevocable trust usually has no effect on one’s lifestyle. If properly drafted, an irrevocable medicaid trust can protect the home from long-term health care costs and from creditors, while at the same time provide great flexibility. One can retain the right to reside in the home for the rest of his or her life, and also direct that the home be sold and another be purchased in its place. The trust can also be designed to prevent capital gains tax problems and to preserve senior citizen and veterans tax exemptions. Lastly, by transferring your home to a trust you not only avoid probate (in connection with the home) but you also avoid the dangers inherent in transferring your home directly to your children.
Of course, one should consult with an experienced attorney with expertise in estate planning and taxes before embarking on the creation of any trust, and such a creation should be done in connection with developing a comprehensive estate plan.
* * * * * *
IRS Circular 230 disclosure: We inform you that any tax advice contained in this communication is not intended or written to be used, and may not be used by your or anyone else for the purpose of avoiding penalties imposed under the Internal Revenue Code.